The bond market is back with a vengeance

Bonds are back with a vengeance as volumes hit near-historic highs this week. Not only are higher yields generating positive returns, even if rates continue to rise, but the new issuances in both government and corporate bonds are on the rise.

Volatile inflows into bond ETFs

Over the last year flows into bond exchange traded funds have been volatile. While the Fed went through the period of aggressive hiking, investors piled into longer-dated debt expecting that the US would slide into recession. This would then be followed by an inflation crash and the Fed performing a U-turn on rates – so the narrative went.

Consequently almost $32 billion poured into bond ETFs over the last 12 month, a record high. The process slowed down at the start of the summer but now with the holiday season over, and with only two weeks to go before the next Fed rate meeting, bond market activity is back in full gear.

The markets have positioned themselves for a halt to rate hikes, followed by a period of rate reductions in early 2024, yet it might be too early for investors to celebrate disinflation (a period when price growth slows down temporarily, not to be mixed up with deflation, a period when prices fall), warns says Aneeka Gupta, director of Macroeconomic Research at ETF provider WisdomTree.

“Overall, the US economy continues to show extraordinary resilience despite monetary constraints and credit tightening. While inflation has shown encouraging signs of decline, we caution that the level remains high,” says Gupta.

The US labour market remains tight, with unemployment at historic lows and wages still rising. In August, wages in the US grew by 3.2% while overall inflation stood at 4.2%.

Commodity prices have also rebounded from the weakness in the second quarter, oil in particular. Saudi Arabia made sure of that, vouching to extend OPEC’s existing supply cuts into December. If commodity prices extend their recent momentum this would create upside risks to inflation.

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For the Fed this could mean having to fine-tune its rate position, and instead of keeping rates flat for now, potentially opting for another increase before the year is over.

Government vs corporate debt

New issuances in US investment-grade rated companies have created some pressure on long-term US Treasuries with investors moving into top-rated corporate debt because of higher yield. Nevertheless, with 10-year Treasury yields near 4%, Treasuris remain at an attractive level to add longer-dated assets.

Since the start of September Barclays, Nestlé and Toyota issued new bonds and according to Reuters, there could be another $100-$150 billion in new bond issuances this month.

The US Treasury is also expected to have an issuing spree this autumn to restore its cash balance and catch up on the period it lost during the US debt ceiling showdown.

The process had already started before the summer and a total of $1 trillion in bills, notes and bonds is expected to be issued in the last two quarters. While some investors were sceptical about how much of new debt the market could absorb, so far the response from money market funds to additional T-bill supply has been very positive.

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