As the year comes to a close, we revisit some of the key market themes and moves for 2024.
The “rates pendulum” swung widely as markets contended with strong economic data start the year, buffered by fears of an economic contraction late summer as labor markets showed signs of slowing. Although the US economy remained solidly in expansion, the Fed began lowering its policy rate in September, which combined with expectations of an economic boost from a Republican sweep, resulted in a shift higher in bond yields into the end of the year. The 2Y Treasury yield moved lower by just 3 basis points on the year, despite trading in a 150-basis-point range. Longer term interest rates increased this year, with the 10Y Treasury yield rising by 51 basis points, pushing the 2Y-10Y yield curve steeper into positive territory.
Corporate bonds experienced a remarkably stable year as spreads continued to fall to multi-decade tights. Despite a brief volatility episode at the beginning of August, investment grade corporate spreads have compressed by 24 basis points this year, while high yield corporates, a segment that has seen marked improvement in the quality of issuers, saw 61 basis points of tightening. The combination of a resilient US economy alongside fiscal and monetary support should see the continuation of the credit cycle amid the lack of near-term catalysts for a default cycle.
Notably, mortgaged-backed securities spreads have moved lower only by 3 basis points on the year, in lockstep with Treasuries. The sector has been affected by the lack of demand from commercial banks and the change in FOMC policy that had supported the segment during the days of quantitative easing. We believe that interest rate volatility will continue to decline as the Fed continues on its rate cutting path in 2025, so MBS should be a beneficiary, especially at some of the best valuations in years.
Money markets have been the most popular asset class over the past three years, with the highest yield on cash continuing to attract capital that had been accustomed to zero interest rates. Despite the Fed pivot, money markets attracted nearly $900 billion in 2024, and demand has shown few signs of easing. One of the big questions as the Fed continues to lower interest rates is whether money market fund assets flow to other fixed income sectors or further down the spectrum to risk assets. The key driver may not be the level of interest rates; if economic growth slows, money market assets could continue to build, while a stronger fundamental picture could result in cash moving into riskier asset classes.
The year ahead for fixed income will be marked by path of inflation and the actualization of Trump 2.0 policies – set against a valuation backdrop that is priced for perfection due to a supportive mix of economic fundamentals and stimulative public policies. With a strong, resilient consumer few signs of credit stress, spreads are poised to remain tight. The rate picture will be driven by the interplay between the Fed’s reaction to a strong economy and the fiscal deficit picture, which we believe continues to favor an asymmetric path lower for bond yields next year.
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