Fixed income update: Bond markets retreat in January | Vanguard UK Professional (2024)

In January, fixed income markets reversed their December rally, as more robust inflation, growth and labour market data led investors to pare back rate cut expectations that had already been priced in. Developed-market government bond yields pushed higher, particularly at the long-end of the yield curve. In the US, yields on long-dated 30-year Treasuries hit their highest levels in over six weeks.

Inflation levels in the US, UK and Europe ticked higher in December, but are still far below the double-digit levels they reached this time last year. In the US, headline inflation rose to 3.4%, while core inflation (which excludes volatile energy and food prices) fell to 3.9%. In the UK, headline inflation rose to 4%, while core inflation remained at 5%. In Europe, headline inflation rose to 2.9%, while core inflation fell to 3.4%.

In the US, robust employment figures continued to defy expectations, with non-farm payrolls nearly doubling in December and average hourly earnings remaining strong. Retail sales also rose higher than expected, signalling a resilient consumer.

Oil prices rose in January, owing to tensions in the Middle East, where events in the Red Sea have raised concerns around supply chain disruptions and increased shipping costs.

At January’s central bank meetings, the US Federal Reserve, Bank of England and European Central Bank left their interest rates unchanged at 5.5%, 5.25% and 4%, respectively. The Bank of Japan maintained its key interest rate at -0.1%, while also leaving its yield curve control policy unchanged, although the policy statement continued to uphold an easing bias.

Monthly performance by market

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source:Bloomberg; for the period 31 December 2023 to 31 January 2024. Bloomberg indices are used as proxies for each exposure. Calculations are in USD.

Government bonds

Government bond yields pushed higher in January at the long-end of the yield curve. In the US, two-year Treasury yields fell by 4 basis points (bps), while 10-year yields rose by 3 bps. In Europe, German two-year yields rose by 3 bps, while 10-year yields rose by 14 bps. In the UK, two-year and 10-year yields rose by 27 bps and 26 bps respectively, while 30-year yields rose by 31 bps.

Credit markets

Investment-grade (IG) credit spreads broadly tightened in January, with US, eurozone and UK IG spreads tightening by 7 bps, 14 bps and 11 bps, respectively¹. However, emerging markets (EM) credit spreads widened over the month, with EM IG and EM high-yield (HY) spreads widening by 18 bps and 23 bps, respectively². Global HY spreads widened by 9 bps³.

Changes in spreads

Source:Bloomberg indices: Global Aggregate Credit Average OAS Index, Global Aggregate Supranational Index, US Aggregate Corporate Average OAS Index, Euro Aggregate Corporate Average OAS Index, Sterling Aggregate Corporate Average OAS Index, US Aggregate ABS Average OAS Index, US Aggregate CMBS Average OAS Index, Global High Yield Average OAS Index, JP Morgan EMBI Global Diversified IG Sovereign Spread Index, JP Morgan EMBI Global Diversified HY Sovereign Spread Index. Data for the period 31 December 2023 to 31 January 2024.

We maintain our view that IG company fundamentals are in good shape. With the exception of select sectors (real estate, for example), many corporates have reduced their levels of debt over the past few years and are better positioned in terms of leverage and interest coverage now than they were before the pandemic. This will help the resilience of credit markets in case the economic slowdown is more pronounced, and recovery comes later than expected.

In Europe, fourth-quarter earnings results continue to gather pace. Market expectations are for STOXX600 corporate earnings (which include Europe’s largest companies by market capitalisation) to decrease by approximately 2% (excluding the energy sector) and for revenues to remain flat with last year. It’s still early days in the earnings season, but so far we’ve not observed any major negative surprises.

Emerging markets

EM corporate bonds declined -1.0% in January, as a front-loaded influx of new issue supply repriced the market and pushed spreads wider, particularly in IG corporates. IG bonds underperformed HY bonds, falling -1.4% versus -0.7% for HY bonds over the month⁴. IG issuers took advantage of the re-opening of the primary market, issuing large volumes of new bonds. Having dropped to extreme levels at the end of 2023, the supply of new issuance pushed IG spreads 17 bps wider during the month⁵.

At these levels, EM IG and EM HY spreads are near their most attractive levels versus US corporate spreads in two years, in our view. EM credit presents a compelling near-term opportunity to add risk, given that much of EM new issuance is likely to be concentrated at the start of the year. As a result, demand for EM bonds is likely to outpace supply in the coming months.

EM credit spreads near their widest levels vs US spreads in two years

Source:Bloomberg and JP Morgan, for the period from 1 January 2022 to 31 January 2024. Proxies used in IG and EM ratios: EM IG: Investment Grade sub-index of the J.P. Morgan EMBI Global Diversified index; EM HY: High Yield sub-index of the J.P. Morgan EMBI Global Diversified Index; US IG: Bloomberg U.S. Corporate Bond Index; US HY: Bloomberg High Yield Corporate Index.

EM local-currency bonds declined -1.5% in January⁶, in a month where positive performance in local-currency government bonds (+0.6%) was not enough to offset EM foreign exchange losses against the US dollar (-2.1%). Latin America continued to outperform. The region offers compelling valuations, owing to high but falling inflation and central banks that have ample room to cut rates before getting close to their neutral rates.

Outlook

Markets have recently shifted their focus from persistent inflation to growth data and the potential for interest rate cuts. Developed-market central banks have paused their rate hiking cycles, and investors are pricing in rate cuts as early as Q2 2024 in the US. The soft-landing narrative has continued as US growth remains resilient and inflation appears to be moderating, although the manufacturing sector appears to be contracting. There has been a sharp deceleration in international economic momentum, and softening can be seen in the euro area, the UK and China. As we saw in December, there was a significant repricing in yields, although much of this was reversed at the start of 2024, as markets digested strong labour market and growth data. We believe yields remain at attractive levels. Historically, yields at these levels typically have been followed by strong returns over the next six to 12 months for bond investors.

¹ Source: Bloomberg Global Aggregate Credit Index, 31 December 2023 to 31 January 2024.

² Source: JP Morgan EMBI Global Diversified Index, 31 December 2023 to 31 January 2024.

³ Global High Yield Average OAS Index, 31 December 2023 to 31 January 2024.

⁴ Source: Vanguard and JP Morgan. Average spread calculations based on the J.P. Morgan Emerging Market Bond Index (EMBI) Global Diversified Index relative to US Treasuries. Monthly change in spread is for the period 31 December 2023 to 31 January 2024.

⁵ Source: Vanguard and JP Morgan. Average spread calculations based on the J.P. Morgan Emerging Market Bond Index (EMBI) Global Diversified Index relative to US Treasuries. Monthly change in spread is for the period 31 December 2023 to 31 January 2024.

⁶ Source: J.P. Morgan EMBI Global Diversified Index, 31 December 2023 to 31 January 2024.