SSGA: Finding sanctuary in short rates

October 11, 2023

Investors may feel more comfortable sticking to the front end of the curve.

‘Following the brutal sell-off in 2022, this was supposed to be the year that bonds performed. It therefore seems ironic that, with central banks close to having peak rates in place, there has been yet another leg higher in bond yields,’ State Street Global Advisors (SSGA) contemplates today. ‘There are undoubtedly concerns over high deficits and substantial amounts of issuance that the market will have to absorb in an environment where central banks are running down their balance sheet holdings.

However, the main source of bearish tension has been the slower than expected decline in inflation and, in the US at least, more resilient growth. The result is that that central banks have indicated rates will stay elevated for a long period to come. The markets have responded by unwinding some of the pricing of rate cuts but by no means all.’

‘With medium-term easing still at the forefront of the market’s collective mind, there remain risks to the bond market if data stays strong. Given the substantial tightening in monetary policy already put in place, a resilient economy may seem unlikely.’ ‘Seasonally, September and October are a tricky part of the year for fixed income with debt management offices and corporates using the re-opening of the market post the summer lull in trading to issue bonds. Returns from the Bloomberg US Treasury Index have been positive in these two months in only three of the last 10 years.’ ‘In short, if data does not start to soften and the market suffers supply indigestion, then yields could remain elevated in the coming weeks.’

Stick to front end of curve

‘Investors may therefore feel more comfortable sticking to the front end of the curve for a few key reasons:

1. The Fed, the ECB and the BoE have all indicated that central bank rates are close to peaking.’
2. ‘The front end of the curve is more tied in to policy rates and less sensitive to supply pressures.’
3. ‘An inverted yield curve means higher yields at the front end. This results in short maturity funds having a far better yield return per unit of duration than further along the curve.’

‘Sticking to the front end of the curve would have worked well for investors year to date. For instance, returns from the Bloomberg US Treasury Bill: 1-3 Months Index have been 3.66% and it currently has a yield-to-worst of more than 5.4% against returns of -2.4% for the Bloomberg US Treasury Index and a current yield-to-worst of close to 4.9%.’