Corporate and securitized bonds are on course to close 2024 offering higher yields relative to the last 10 years, based on the Bloomberg Corporate Investment Grade (IG) Index.¹ We believe solid fundamental credit factors across most sectors and a substantial increase in supply offer investors incentives to increase allocations to fixed income (See our Q4 2024 Corporate Bond Market Outlook).

Still, there are reasons for a cautious approach to bond markets, including the Federal Reserve’s (Fed’s) shifting monetary policy, the potential for a slowing economy, and relatively tight credit spreads. 

James Spidle, CFA, Breckinridge’s Head of Strategic Partnerships, spoke with Co-Chief Investment Officer Jeff Glenn, CFA, about his view of the markets entering the fourth quarter of 2024 and looking ahead to 2025. Jeff leads portfolio management for the company’s multi-sector bond strategies.²

James Spidle: Let’s start with a macroeconomic view, Jeff. What is the Investment Committee’s take on the current state of the economy?

Jeff Glenn: Our base case is slower growth in the U.S. over the next 6 to 12 months, primarily due to the cumulative effects of tight monetary policy that tend to disproportionately impact small businesses and lower income households.

Inflation trends are improving, but we're still watching stickier segments of the Consumer Price Index like shelter and core services. 

The narrative around rate cuts shifted a few times this year, with the market initially expecting six to seven cuts in 2024. Currently, those expectations are down to cuts totaling about 150 basis points (bps) by the end of 2025. We expect the Fed to cut rates by 25bps in November and December.

The 10-year Treasury ended the third quarter down over 60bps for the quarter but reversed course in October with the yields touching 4.25%. We expect rates to be a little bit more range bound over the next few quarters, with lower highs going forward.

The Treasury curve, as measured by the difference between the 2-year and the 10-year Treasury yield is now positively sloped with the potential of steepening further, as the Fed continues to cut rates next year.

James: Ok, let’s take a closer look at our positioning broadly across the multi-sector portfolios, which include our government/credit and fixed income strategies.

Jeff: Given that valuations are relatively tight and that we expect growth will slow next year, we are targeting a neutral duration with a higher quality bias within our corporate allocation relative to the benchmarks.

The difference between the single-A and triple-B corporate spreads remains tighter than historical averages, based on Bloomberg data. We have not seen investors being compensated for going down in quality, at least in our opinion. 

At this point, we favor stable-to-improving credit stories that we feel have the necessary financial flexibility to weather any earnings downturn that may accompany the Fed’s shift in monetary policy. Our analysts focus on companies that historically have had stronger free cash flow generation relative to their peers, and that have paid down debt after acquisitions.

James: Can we drill down a little further on how you are structuring the government/credit portfolios?

Jeff: Typically, we structurally overweight corporate and taxable municipals and underweight Treasuries within the Intermediate Government/Credit strategy. We're currently at the low end of our targeted allocation range for corporates.

The reason is that while fundamentals remain solid for most of the IG issuers, we are cautious given tight valuations and an expectation that earnings growth will slow next year.

We're still finding some value in the front end, particularly financials in that 3- to 5-year part of the curve. We view utilities positively. 

Within the government-related sector, taxable municipal bonds have been a differentiator for Breckinridge multi-sector strategies, tracing back to the firm's roots. We leverage our deep expertise in the muni market from the research and trading perspectives.

“Based on Bloomberg data over the last 20 years, taxable munis have generated strong risk-adjusted returns and have been less correlated to other IG bond sectors. It is a highly rated sector, similar to the tax-exempt side. The majority of issues are rated AA by the agencies and, as the third quarter was closing, spreads widened somewhat, opening some opportunities to add.”

James: After a period of low-to-zero yields, bond investors welcomed the higher rates that came with the Fed’s tightening campaign. While yields have trended lower recently, Bloomberg data shows they still are at levels not seen in more than 10 years on the corporate side. How have our strategies fared in the environment?

Jeff: Historically the yield to maturity of a bond has been a good proxy of future returns. Year-to-date total returns across IG fixed income sectors were solid through September 30; in the 4 percent to 5 percent range, based on the Bloomberg U.S. Government/Credit³ and Aggregate⁴ bond indexes. 

We believe that is a reasonable total return guide for the next 12 months. Obviously, if rates were to rally or sell off significantly, that figure could be higher or lower. And, it is worth noting that with yields at more normalized levels, coupon income can help cushion returns if rates were to rise sharply later this year or next year. And that's very different than where we were in 2022 when yields were notably lower and the cushion was not as generous.

James: Entering a potentially volatile period ahead in the markets, how are you thinking about these factors?

Jeff: The spread environment remains tight. As a result, we are positioned somewhat defensively on the expectation that better opportunities to put money to work at wider spreads will emerge at some point.

It is always challenging to forecast economic growth, especially coming out of the extraordinary circumstances that followed the COVID-19 pandemic economically as well as for business and market cycles. We think we're still in the later innings of this cycle. 

In terms of investment style, we look at where we are both in the business cycle and in the spread environment. We take an opportunistic value approach, which means that we look to shift our risk posture when we find attractive risk/reward propositions within specific sectors. 

James: Within our core fixed income strategies, what sectors look the most attractive?

Jeff: In the current environment, we believe IG securitized bond sectors look interesting, especially compared with corporates.

While Bloomberg data shows corporate spreads have tightened to the low end of historical averages, mortgage-backed security spreads remain range-bound, and we believe they will offer attractive risk-adjusted returns as rate volatility subsides. The BBG MBS Index⁵ earned an excess return of 52bps year-to-date through September 30, 2024. 

The start of a rate-cutting cycle, the reversion of the Treasury yield curve to a positive slope, and the return of one of the MBS segment’s biggest buyers historically—Banks—combine as a potential tailwind for the sector moving forward.

Asset-backed securities also continue to look attractive given the sector’s high quality, short duration characteristics, wider relative spreads, and a strong technical backdrop in 2024. Year-to-date through September 30, 2024, based on BBG ABS Index data,⁶ credit card ABS delivered an excess return of 90bps and auto loan ABS earned an excess return of 51bps. 

YTD issuance of more than $272 billion—a record, according to Bloomberg—underpins a solid technical environment. Consumer trends, including lower levels of unemployment and household leverage support the outlook for ABS.

[1] The Bloomberg U.S. Corporate Bond Index is an unmanaged market-value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more. You cannot invest directly in an index.

[2] The views expressed in this article are as of October 31, 2024.

[3] The Bloomberg Intermediate Government/Credit Bond Index is an unmanaged index comprised of U.S. government agency and Treasury securities and investment grade corporate bonds. You cannot invest directly in an index.

[4] The Bloomberg Aggregate Bond Index measures the performance of a broad range of fixed-rate, investment grade, taxable bond securities in the U.S. dollar market. You cannot invest directly in an index.

[5] The Bloomberg MBS Index tracks agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual pools into aggregates or generics based on program, coupon, and vintage. You cannot invest directly in an index.

[6] Bloomberg Asset-Backed Securities (ABS) Index: Is the ABS component of the Bloomberg US Aggregate Index. The Asset-Backed Securities (ABS) Index has three subsectors: credit and charge cards, autos and utility. The index includes pass-through, bullet and controlled amortization structures. The ABS Index includes only the senior class of each ABS issue and the ERISA-eligible B and C tranche.

BCAI-11012024-glilvpgl (11/12/2024)

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