Bond markets largely struggled amidst rising yields
Key takeaways for the quarter ended March 31, 2024
- In the first quarter, the fixed income market was pressured by higher yields as investors recalibrated their expectations of rate cuts on the back of resilient economic data. Below investment grade (BB/Ba and below) debt was a notable exception, with both high-yield corporate bonds and municipals landing in positive territory.
- Over longer term periods, the majority of fixed income American Funds continued to deliver positive absolute returns and positive relative returns compared to their primary benchmarks.
- We believe important portfolio roles for fixed income funds include income, inflation protection, capital preservation and diversification from equities. Capital Group offers investments that balance these roles across fixed income mutual funds and exchange-traded funds (ETFs).*
Fixed income market results were largely negative in the first quarter amidst higher yields. Treasury yields ended the quarter higher and the yield curve was marginally more inverted (where short-term interest rates are higher than long-term rates) as resilient economic data contributed to investors’ lowered expectations for future rate cuts. Credit spreads tightened somewhat, especially in high-yield, and shorter duration bonds generally outperformed their longer duration counterparts. Duration indicates a bond fund’s sensitivity to interest rates; generally, lower duration indicates less sensitivity. The Bloomberg U.S. Aggregate Index returned -0.78% for the quarter.
The Federal Open Market Committee (FOMC) kept rates on hold in the quarter on their path to lower inflation towards an average level of 2%. The U.S. Federal Reserve (Fed) remained focused on the timing of rate cuts in response to softer inflation and continued resilience in economic data.
Despite stronger than expected data early in the quarter, inflation generally continued softening. Inflation continued to trend lower but the road to hitting the Fed’s 2% target will likely be bumpier than previously anticipated. Recent decelerations have come from goods prices and rents while services remain relatively sticky.
Softening inflation paves the way for the next move for the Fed to begin to cut interest rates. However, given resilient economic growth, the timing and extent of the cuts remains uncertain. The two-year, five-year, 10-year and 30-year Treasury yields increased 37 basis points (bps), 36 bps, 32 bps and 31 bps, respectively. The 10-year Treasury yield ended the quarter at 4.20% and the two-year Treasury yield ended the quarter at 4.62%. Treasury yields generally rose across the curve during the quarter as the market recalibrated expectations of Fed rate cuts. We believe as inflation moderates and central banks are poised to end rate-hiking cycles, this should provide a supportive backdrop for fixed income assets.
Credit spreads across high-yield and investment-grade markets generally tightened over the quarter. Investment-grade (BBB/Baa and above) credit spreads ended the quarter at 90 bps over Treasuries, tighter by 9 bps compared to the previous quarter-end. High-yield credit spreads ended the quarter at 299 bps over Treasuries, tighter 24 bps from December 2023. The yield to worst on the Bloomberg U.S. Corporate High Yield Index was 7.66% as of March 31, 2024.
Sources: Bloomberg Index Services Ltd., RIMES. As of 3/31/24. Past results are not predictive of results in future periods.
Source: Bloomberg Index Services Ltd. As of 3/31/24. Past results are not predictive of results in future periods.
US fixed income markets largely negative in the first quarter amidst higher yields
U.S. bond market returns were generally negative for the quarter, with the notable exception of taxable and tax-exempt high yield. Assets with shorter duration outpaced their longer duration counterparts as yields generally rose.
Within this environment, 15 of our 24 fixed income mutual funds and ETFs had positive absolute results for the quarter. For relative returns, 16 of our 24 fixed income mutual funds and ETFs delivered results in line (within 10 bps) or ahead of their primary benchmarks. Generally, funds with more duration and less credit exposure tended to be more challenged during a period when yields rose and credit spreads generally tightened amidst a broader market rally.
Anchoring your portfolio with disciplined fixed income funds and ETFs
Given the potential for decelerating but historically elevated inflation and a more favorable macroeconomic outlook, we believe a disciplined approach to overall portfolio construction will remain critical. As a result, we are looking to construct portfolios that reflect balanced risks across excess return drivers and diverse macroeconomic outcomes. Broadly, fixed income may help provide income, preserve capital, diversify from equity risk and pursue inflation protection -- all of which can be vital for investor portfolios as the market remains uncertain.
Funds like American Funds Strategic Bond Fund for a core plus allocation, The Bond Fund of America® and The Tax-Exempt Bond Fund of America® for a core allocation, and American Funds Multi-Sector Income Fund to pursue diversified income, are all building blocks that can help investors seek prudent portfolio construction and pursue these investment goals.
The Bond Fund of America (ABNFX, Class F-2), our flagship core mutual fund, takes a gradual, balanced approach to core investing. Fund managers use a disciplined, value-based approach to sector positioning, striving for strong security selection in corporate bonds, mortgage-backed securities (MBS) and U.S. Treasury notes. The fund outpaced its benchmark, the Bloomberg U.S. Aggregate Index, over the 3-, 5- and 10-year periods (by 16 bps, 75 bps and 38 bps, respectively).
American Funds Strategic Bond Fund (ANBFX, Class F-2) uses a differentiated, disciplined approach that focuses primarily on duration, yield curve and inflation positioning, with a lesser, more opportunistic focus on credit sectors. The fund can help anchor a bond allocation, while aiming to maintain lower correlation with equities. It has delivered positive excess returns versus the benchmark, the Bloomberg U.S. Aggregate Index, over a long-term five-year period (108 bps).
The Capital Group Core Plus Income ETF (CGCP) can help anchor a portfolio while pursuing a consistent income. CGCP (market price) outpaced its primary index, the Bloomberg U.S. Aggregate Index, by 84 bps for the quarter. The ETF leverages multiple sources of active return potential, balancing preserving capital and pursuing income while also seeking total return. It invests across a diversified set of income sectors, including investment-grade and high-yield credit, securitized credit and emerging markets (EM) debt, aiming to generate a resilient income stream.
The Tax-Exempt Bond Fund of America (TEAFX, Class F-2), our most diversified municipal bond mutual fund, exceeded its benchmark, the Bloomberg Municipal Bond Index, over the 1-year (86 bps), 3-year (16 bps), 5-year (10 bps) and 10-year (8 bps) periods. The fund focuses on investment-grade securities, with the flexibility to own higher income securities across the rating spectrum. TEAFX takes a risk-aware approach and seeks to add value through selectivity of both credit and interest rate exposures.
The Capital Group Municipal Income ETF (CGMU) is a single-solution core municipal bond allocation that incorporates high-yield municipal bonds in its pursuit of resilient income. CGMU (market price) outpaced its primary index, the 85%/15% Bloomberg 1-15 Year Blend (1-17 Year) Municipal Bond Index/Bloomberg 1-15 Year Blend (1-17 Year) High Yield Municipal Bond Index, by 53 bps for the quarter. The ETF seeks to provide investors a tax-exempt income stream, capital preservation and total return.
American Funds Multi-Sector Income Fund (MIAYX, Class F-2) outpaced its blended benchmark over the 3-year (94 bps) and 5-year (136 bps) periods, highlighting the advantage of its distinctive approach. The fund is designed to pursue opportunities diversified across multiple fixed income sectors and seeks to provide high income.
The Capital Group U.S. Multi-Sector Income ETF (CGMS) is an option for investors seeking a higher income bond allocation. CGMS (market price) outpaced its primary index, the Bloomberg U.S. Aggregate Index, by 243 bps for the quarter. This U.S.-focused ETF leverages Capital Group’s research capabilities across a range of income sectors, both investment-grade and non-investment-grade (BB/Ba and below), while managing credit risk and volatility.
Market outlook
Looking ahead, some portfolio themes include:
- Interest rates: The yield curve steepener continues to be a preferred position given current valuations, although the benefits of the position may not be realized in the near-term. An inverted yield curve is not a normal condition over extended periods. The yield curve has been inverted for 21 months — the longest period in seven decades. Curve positioning is expected to benefit portfolios in a variety of scenarios, including: the Fed actively cutting rates, a recession, or the long end of the yield curve rising more (or falling less) than the front end due to federal deficit or Treasury supply concerns.
- MBS: Agency mortgage-backed securities valuations continue to remain attractive relative to other sectors, even as valuations have tightened and are less compelling than last year. While the technical picture is more mixed, fundamentals are generally supportive. We continue to favor agency MBS, where managers focus on coupon selection.
- Investment-grade corporate credit: Modest and diversified exposure to select credit sectors should benefit from a benign macro environment. Credit fundamentals are supportive and spreads, although tight with little room for further compression, are likely to remain range-bound. Managers believe valuations for investment-grade corporates appear relatively more attractive than those for high yield and EM debt, the latter of which is vulnerable to weakness in China. Still, idiosyncratic opportunities exist broadly across all sectors. Securitized credit and EM corporates may also offer attractive risk‐reward opportunities.
Fixed income remains a component for investors that seek balanced portfolios. As we wait to see the Fed’s next actions, there are multiple areas of opportunity. We believe fixed income can continue to serve the four roles of income, inflation protection, capital preservation and diversification from equities.
* This commentary excludes the American Funds Portfolio Series and American Funds Insurance Series fixed-income mutual funds.
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The Bloomberg U.S. Corporate High Yield Index covers the universe of fixed-rate, non-investment-grade debt. The Bloomberg U.S. Aggregate Index represents the U.S. investment-grade fixed-rate bond market. The Bloomberg High Yield Municipal Bond Index is a market-value-weighted index composed of municipal bonds rated below BBB/Baa. The 85%/15% Bloomberg 1-15 Year Blend (1-17) Municipal Bond Index/Bloomberg 1-15 Year Blend (1-17) High Yield Municipal Bond Index blends the Bloomberg 1-15 Year Blend (1-17) Municipal Bond Index with the Bloomberg 1-15 Year Blend (1-17) High Yield Municipal Bond Index by weighting their cumulative total returns at 85% and 15%, respectively. The blend is rebalanced monthly. Bloomberg 1-15 Year Blend (1-17) Municipal Bond Index consists of a broad selection of investment-grade general obligation and revenue bonds of maturities ranging from one year to 17 years. Bloomberg 1-15 Year Blend (1-17) High Yield Municipal Bond Index consists of a broad selection of below-investment-grade general obligation and revenue bonds of maturities ranging from one year to 17 years. The Bloomberg Municipal Bond Index is a market-value-weighted index designed to represent the long-term investment-grade tax-exempt bond market. American Funds Multi-Sector Income Fund Custom Index comprises 45% Bloomberg U.S. High Yield Index 2% Issuer Cap, 30% Bloomberg U.S. Corporate Investment Grade Index, 15% J.P. Morgan EMBI Global Diversified Index, 8% Bloomberg CMBS ex AAA Index and 2% Bloomberg ABS ex AAA Index, and blends the respective indices by weighting their cumulative total returns according to the weights described. This assumes the blend is rebalanced monthly. Bloomberg U.S. Corporate High Yield 2% Issuer Capped Index covers the universe of fixed-rate non-investment-grade debt. The index limits the maximum exposure of any one issuer to 2%. J.P. Morgan EMBI Global Diversified Index is a uniquely weighted emerging markets debt benchmark that tracks total returns for U.S. dollar-denominated bonds issued by emerging markets sovereign and quasi-sovereign entities. Bloomberg U.S. Corporate Investment Grade Index represents the universe of investment-grade publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity and quality requirements. Bloomberg CMBS ex AAA Index represents the universe of U.S. commercial mortgage-backed securities, excluding issuers with credit ratings of AAA, the highest credit quality rating. Bloomberg ABS ex AAA Index represents the universe of U.S. asset-backed securities, excluding issuers with credit ratings of AAA, the highest credit quality rating. The indexes are unmanaged, and results include reinvested distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes. The fund’s composition is based on internal classifications and prospectus requirements, while the custom index’s composition is based on each component index provider’s respective sector classifications.
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