Bond markets surprised in late 2023, but how will this play into this year, given interest rates are expected to be lowered by central banks? Stuart Chilvers, Rathbone Ethical Bond Fund Manager, considers the angles.
So much for winding down into Christmas, bond markets had an absolute whirlwind final two months of the year!
In November the Bloomberg Global Aggregate investment grade bond index had its strongest month since December 2008; generally, it didn’t matter which bond index you used, corporate and government bond returns for the final two months of 2024 weren’t far from double digits. Not only did this mean that some of the earlier 2024 outlooks that came into my inbox were rendered outdated rather swiftly (my sympathies with the authors given the level of detail in them!), but it also left credit markets looking at pretty decent returns for 2023. For instance, the ICE Bank of America Sterling Corporate bond index returned almost 10% for the year.
The drivers of this end of year rally have received plenty of coverage. Briefly, in October the US Treasury market was under pressure as investors fretted that the government was spending more money than bond investors would be willing to buy at auction. As it turned out, the government issued fewer long-dated treasuries than investors were expecting. Meanwhile, alongside the Treasury’s refunding announcement, soft inflation data and signs that the American labour market was cooling in a helpful way fostered optimism regarding a soft landing. Then the US Federal Reserve (Fed) topped it all off with much more dovish commentary than we have seen in some time. In short, rates and credit rallied significantly.
It’s interesting to note, however, that the minutes of the Fed’s December meeting (released in early January) seemed less dovish than Chair Jay Powell came across in the post-meeting press conference, in our opinion. Also, the market moves were likely exacerbated to a degree by the traditionally poor liquidity that surrounds the holiday season.
Investors gobble up issuance
At some point between turkey and Christmas pudding, my mind drifted to corporate treasurers and the likely rush of issuance we would see at the start of 2024. I know, I’m a sad guy – but that’s why I’m in this job!
January, commonly, is a heavy month of issuance after a sleepy December – and most investors expected this year to be no different. Especially given the significant falls in borrowing costs in the fourth quarter, as well as a market over the previous couple of years which has not been particularly straightforward at various times for issuers – trying to price a bond while yields are volatile and rising is a nightmare for companies. With volatility and yields lower, many businesses will be scrambling to lock in better funding costs. Yet how might this supply be received by investors?
At the back-end of the year, in a strongly performing market, flows were heavily skewed towards buying, so it seemed that new issuance supply would help to alleviate this technical imbalance. On the other hand, given the scale of the rally mentioned above, investors may be wary of buying at what could turn out to be high prices.
At the time of writing, we’re only seven trading days into the new year, yet the answer has so far been fairly unequivocal: issuers have been able to tighten deals significantly from their initial pricing and books have been generally heavily oversubscribed. While credit spreads have widened alongside this issuance, the moves have been relatively orderly and only returned us to the levels we saw in mid-December. Indeed, after their initial rise, spreads have started to tighten again, with some investors surprised by lower issuance than they had expected.
It seems plausible that investor inflows into credit markets could further help support the positive technical picture. The significant flows into money markets last year are well documented – a record £4.4 billion was deposited in cash funds according to market plumbing provider Calastone. But with investors now focused very much on the timing of the first rate cut rather than how high rate hikes will go – plus the last few months of 2023 creating a stark reminder that rates can drop rapidly as the cycle pivots – we wouldn’t be surprised if any 2024 increases in bond yields are met with inflows into bond funds as investors look to lock in their long-term yields. Especially if inflation continues to drop and the yields on offer – for cash and everything else – fall meaningfully in response.
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