What happened last week?

  • Central banks: In the US, the tone was mixed from Fed members on the future of the Fed's monetary policy. On the one hand, some of them left the door open for more action (50bp hike in March?) and longer (no reduction before H2 2024?), on the other hand, Bostic said he would only support a 25bp hike and that a pause could be preferred by the summer. In Europe, Lagarde left no doubt about a further 50 basis point hike at the next ECB meeting.
  • Rates: While the entire U.S. Treasury yield curve briefly rose above 4% on Thursday, U.S. Treasuries ended the week with a positive weekly performance thanks to Bostic's "dovish" comment. In February, the Bloomberg U.S. Treasury Bond Index fell 2.4% and is still negative in March. This poor performance was accompanied by a spike in U.S. rate volatility, with the MOVE index ending the week at 122. Note that for the first time, the US Treasury yield curve reached -100 bps between the 3-month and 30-year rates. In Europe, the Bloomberg EUR Treasury index is down -0.5% year-to-date after falling 2.3% in February. The German 10-year Treasury yield ended the week above 2.7%, the highest level recorded since 2011. Finally, the Italian 10-year government bond yield ended the week above 4.5% for the first time in 2023.
  • Credit: The outperformance of U.S. Investment Grade (IG) corporate bonds relative to U.S. Treasuries remains in place (+0.9% vs. -0.1%), primarily due to the resilience of the U.S. economy. IG credit spreads have tightened by 15 bp so far in 2023, despite tremendous primary market activity. Indeed, U.S. IG companies issued $150 billion in February, well above the 3-year historical average of $90 billion. In the high yield segment, 2023 performance (+2.8%) has been excellent so far. The market is reassured by the diminished risk of recession for 2023, but it should be noted that some stress is setting in, with the highest default rate since September 2021 occurring in January! While the default rate remains low (2.2% in January), U.S. high yield companies are being downgraded at their fastest pace since 2020. While European investment grade bonds have underperformed (+0.3%) compared to U.S. bonds since the beginning of the year, European high yield has gained over 3% so far. The Itraxx Xover is now trading below 400bps.
  • Emerging market: Emerging market corporate bonds had a tough month, falling 2.4% in February, but remain in positive territory year-to-date (+0.8%). The main driver is obviously the rise in US interest rates. But idiosyncratic risks are emerging, particularly in Latin America where Brazilian companies have suffered significantly. Americanas, BRF, Gol and Light, all Brazilian companies, are among the worst performing emerging market companies in 2023.

Our view on fixed income (February):

The front end offers a decent carry and low-rate sensitivity, while the historical level of yield curve inversion argues for staying away from the long end. Recent positive economic surprises in the US, analysis and recent deterioration in liquidity could also argue for further upward pressure on long-term yields.



Despite the recent tightening of spreads, the risk/reward remains attractive due to the high level of carry and lower rate volatilityexpectations. While we were already positive on the front end of the credit yield curve, we are moving to longer investments in the 5-10 year segments. 


Emerging market bonds have rallied impressively, outperforming investment grade US corporate bonds by more than 5% over the past six months. But rising idiosyncratic risks and the tight premium to investment grade bonds make us tactically cautious.


The contrarian view: 
subordinated debt!

One of our favorite fixed income segments, offering attractive valuation (in relative terms) despite the recent rally. The sector continues to benefit from strong capital position, low non-performing loan ratios and balance sheets that remains well provisioned.

The Chart of the week:

U.S. inflation expectations rebounded strongly in February!


Source: Bloomberg

What primarily led to one of the worst months for fixed income investments was the strong rebound in U.S. inflation expectations. February saw one of the largest monthly increases in 1-year inflation expectations, while 2-year inflation expectations rose from 2% to 3.2% in a month and a half.

Is it enough to convince the Fed to raise rates by 50 bp instead of 25 bp as expected at its next FOMC meeting?


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