Fixed Income Securities

Government bonds underperformed equities, credit and commodities in this 3-year risk on market. Our analysis shows when equities sell off, Treasuries are also less diversifying compared to decades prior (chart). What’s happening? Long bond yields are made up of 2 components: ➡️ Policy path - in a world shaped by supply, central banks are more limited in their ability to come to the rescue of the economy without reigniting inflationary pressure. Hence Treasuries are less reliable when equities fall. ➡️ Term premium - it’s driven by bond volatility, inflation uncertainty, and of course fiscal dynamics. Think of it like any other type of risk premium such as equity risk premium it’s about perceived risk and additional required compensation above risk-free for holding it in portfolios. Large deficits record debt and heavy issuance mean that term premia can reprice higher, maybe especially during stress, pushing long yields up even as markets may price a lower policy path. Together, these forces weaken the traditional stock–bond hedge. I think of Treasuries now as quality income assets not the diversifiers they used to be.

Use this simple approach to master the Bond Market. Nominal bond yields can be thought of as the interaction between: 1️⃣ Growth expectations 2️⃣ Inflation expectations 3️⃣ Term premium 1. Growth expectations When it comes to economic growth we must consider two angles: structural and cyclical growth. Structural economic growth can be generated through more people joining the labor force (good demographics) and/or through a more productive use of labor and capital (strong productivity trends). The ability of an economy to generate structural growth is an important driver behind long-dated bond yields (strong structural growth = structurally higher long-dated yields and vice versa). Short-term economic cycles also matter for bond yields and particularly at the short-end. Cyclical growth trends are driven by the credit cycle, the fiscal stance, earnings growth, labor market trends and more - the healthier they are, the higher short-end bond yields can be pushed also as a result of a likely tightening from Central Banks that might grow worried about economic over-heating and inflationary pressures in such an environment. 2. Inflation expectations The second component driving nominal bond yields is inflation: but NOT TODAY'S inflation - instead we are referring to long-term inflation expectations. Central Banks might temporarily react to concentrated bursts of inflationary pressures by raising short-term interest rates but when it comes to long-dated bond yields investors will always pay close attention to inflation expectations. That's because consumers and borrowers will tend to make important decisions based on these rather than on volatile short-term trends in inflation. 3. Term premium An investor looking to get fixed income exposure can do that via buying 3-month T-Bills and rolling them each time they mature for the next 10 years. Alternatively, it can decide to purchase 10-year Treasuries today. What's the difference? Interest rate risk! Buying a 10-year bond today rather than rolling T-Bills for the next 10 years exposes investors to risks – term premium compensates for this risk. The lower the uncertainty about growth and inflation down the road, the lower the term premium and vice versa. 💡 The Main Takeaway 💡 If you want to make sense of bond yields, a useful approach to use is to think of them as the result of growth expectations, inflation expectations and term premium. P.S. If you liked this post you'll love my macro research. I share my macro analysis every day with the biggest institutional investors and hedge funds in the world. Get your FREE trial here👇🏼 https://lnkd.in/dyFFJp-z

At 88 bps, the term premium is well above the financial repression era lows of the past decade, but it remains well below levels that we might consider normal over the past 5 decades. My guess is that the term premium is on its way to 150 bps or so, which depending on what happens to inflation expectations could push the 10-year well above 5%. The stock market will not like that, and neither will the dollar. Why does this matter? For two reasons. One, as the stocks/ bonds correlation chart shows below, the higher yields go the more correlated bonds tend to become to equities. The purple dots show the correlation of long-term Treasuries to the S&P 500 (going back to the 1930’s) and the black circles highlight the period since 2020. The Great Moderation Era of the 2000’s and 2010’s is likely over, and we are back to the more traditional era of the 1960’s-1990’s. Two, the more correlated bonds are to equities, and the more competitive bond yields become to equity yields, the more impact those rising yields have in forcing equity valuations to correct. That’s at the heart of the Fed model, favored by the Maestro Alan Greenspan during the 1980’s. The model only works when rates are not being suppressed by central banks through zero interest rate policy (ZIRP) and Quantitative Easing (QE). The bond vs equity valuations chart and the DCF grid both indicate that a return to 5% for the risk-free rate could force the equity P/E-multiple to drop 3-4 points from here. That would be a 15-20% haircut to price, before adjusting for the offset from earnings growth. That’s consistent with the trading range thesis.

Bond yields moved higher in the first two months of the year as the market repriced #Fed expectations. But what’s the outlook for interest rates and fixed income investments as we kick off March?   While we anticipate another healthy employment number this Friday, we still expect 75bps of cuts in 2024, starting midyear. Our near-term range on the 10-year US Treasury #yield is 4% to 4.5%, before moving toward 3.5% by year-end.   While a temporary move toward the top of that range is possible, we believe this would likely require a shock in the form of materially higher #growth or inflation, and we would be strong buyers around the 4.5% level.   In terms of positioning, CMBS continues to outperform, particularly the lower-rated BBB segment. We remain most preferred in the higher-quality CMBS sector. While spreads tightened over the past six weeks, CMBS remains cheap relative to their corporate credit counterpart.   With inflation expectations rising, TIPS have outperformed their Treasury counterparts, and we remain with a preferred allocation in 5-year TIPS given we still think inflation will remain above the Fed’s 2% target this year. Read more in the full report below from Leslie Falconio and John Murtagh.

Considerations for the High Yield Bond Market: The BB-rated High Yield (HY) bond market has shown strong performance, with favorable news recently related to growth and inflation.  Fundamentally, the companies represented in the HY Index have a favorable upgrade-to-downgrade ratio. BB-rated bonds constitute 50% of the HY market, distinguishing them from lower-rated B and CCC companies. BB HY bonds typically feature fixed rate, comparatively lower coupons, resulting in lower liability costs and more manageable debt service. In Contrast, the CCC-rated segment shows a concerning trend, with an upgrade-to-downgrade ratio below 0.5 (2x as many downgrades). The credit quality dispersion, shown in the chart below, reveals that BB vs. CCC-rated bonds trade at a spread margin of ~400 to ~1,200 bps, currently sitting inside of 750 bps.  While CCC credits can generate substantial returns during robust economic growth in a low default rate environment, and have rallied with the market in recent days, CCC deterioration is most pronounced during distress and recession. During the first half of 2020, the BB-CCC spread differential reached 1,200 bps, and in 2016, CCC spreads were even wider. It is noteworthy that Europe is straddling recession, and the BB-CCC European HY bond spreads have recently widened to 1,400 bps, surpassing its peak in 2020. So despite, the recent rally in lower-rated HY bonds, caution is warranted for the weakest segment of corporate credit. The HY bonds historical default rate: BB’s 0.4% default rate, B’s 1.4% default, and CCC’s a stunning 14.3% historical default rate! During a recession, default rates tend to increase significantly from historical measures. Composition of HY Index: 50% BB, 39% B, 11% CCC. 1 year ago, the HY Bond Index had 1.2% default rate. Today, the trailing 12M default for the HY bond market is 2.6%. By Q2 2024, I expect the default rate for high yield bonds exceed 4%. Michael Schlembach, Marathon Asset Management’s PM for High Yield, expects default rates to increase in 2024, with peak default rates potentially reaching ~1.0%, ~3.0%, and >20%+ for BB, B, and CCC’s, respectively. The key will be to invest in the debt of companies with solid fundamentals and financial strength to navigate the pending downturn. If you believe as I do that an economic slowdown (potential recession) is likely in 2024, it might be best to focus on higher quality credits with robust operating businesses within the HY market. Ford serves as a prime example in the BB sector, having recently been upgraded to Investment Grade by S&P, marking it as the largest 'rising star'. Ford represents 2% of the HY index with $41 billion of bonds, its upgrade has spurred demand for other quality BB-rated bonds to replace it. While recent inflows have tightened BB spreads, I advise against trading based solely on the technicals, as this post is intended purely for informational purposes. U.S. HY rated BB vs. CCC Differential:

Global term premia are rising. And Japan's curve is showing it most clearly. After a decade of compressed curves and suppressed term premia, the tide is turning. We’re seeing a regime shift in global bond markets. Term premia, the risk premia and compensation for holding long duration bonds, are rising again. Ironically, and for much of the 2010s, Japanese (and German) yields were the global low yield anchors with negative term premia. Now Japan leads the pack. Why? Three drivers: 1) BoJ balance sheet reduction (quantitative tightening), 2) fiscal concerns, 3) political uncertainty. But there is a neglected point in all of this: Ahead of Japan’s new solvency rules (April 2025), Japanese insurers bought ultra-long JGBs to match liabilities under a market-consistent framework. Now that shift is largely complete. Insurers are no longer adding JGBs at the same pace as a result of the rule change. And with that, a major anchor of the long end is gone, at least for now. So, term premia are back. And they are emblematic of a new macro-financial regime where supply, duration risk, and policy volatility matter again.

Bond Market - Loss of Confidence Jamie Dimon is warning that the US bond market is at risk of a significant disruption due to the country's rising debt and persistent fiscal deficits. He stated, "a crack in the bond market is going to happen," emphasizing that excessive government spending and continued quantitative easing have pushed the system toward instability. US Credit Rating Downgrade and Debt-to-GDP Comparison Moody’s recently downgraded the US credit rating from Aaa to Aa1, joining S&P and Fitch in lowering the country’s rating below the top tier. The downgrade was driven by concerns over the $36 trillion US debt, persistent large deficits, and rising interest costs, which are now "significantly higher than those of similarly rated countries". The US debt-to-GDP ratio stands at about 123% in 2025, ranking it eighth globally—higher than most advanced economies except Japan (with a much higher ratio), but above China (96%) and India (80%). Debt Sustainability and Cost of Borrowing The Congressional Budget Office (CBO) and other analysts forecast that US debt will continue to rise, reaching 156% by 2055 under current policies. Interest payments on the national debt are projected to nearly double over the next decade, reaching $1.8 trillion by 2035 and crowding out other government spending. The sustainability of high debt is increasingly in question: as debt grows and interest rates remain elevated, the US will devote a larger share of its budget to debt service, reducing fiscal flexibility and raising the risk of a fiscal crisis. However, risks remain: persistent deficits, higher inflation expectations, and geopolitical uncertainty could keep yields elevated or even push them higher, especially if investor confidence in US fiscal management erodes. Global Comparison The US debt-to-GDP ratio is among the highest in the world, surpassed only by a few countries like Japan. Compared to other developed markets, US borrowing costs are rising faster due to its unique combination of high debt and large, persistent deficits. Brief Takeaways Jamie Dimon warns of a looming bond market crisis if US fiscal policy does not change. US credit rating is now below the top tier at all major agencies, reflecting fiscal concerns. Debt-to-GDP is at 123%, among the highest globally, with projections for further increases. High and rising debt is unsustainable long-term, significantly raising risks of higher borrowing costs and bond market disruption mainly due to loss of confidence in US market by international and domestic investors . #USDebt #BondMarket #CreditDowngrade #FiscalRisk #TreasuryYields #DebtSustainability #MarketOutlook Jamie Dimon warns US bond market will ‘crack’ under pressure from rising debt - https://on.ft.com/3HldBQO via @FT

Bond markets are sending a blunt message: credibility has a price. Long-dated yields remain stubbornly high, not because inflation is out of control, but because investors no longer trust the fiscal and political anchors in key economies. The so-called “risk-free” rate isn’t risk-free anymore. In the U.S., the Federal Reserve faces its toughest credibility test since the 1970s. Markets see political intrusion—Trump’s second term, probes into Fed officials, open pressure on independence. That uncertainty forces investors to demand more yield to hold Treasuries. The result isn’t a funding crisis, but a higher cost of capital for everyone. In the U.K., Chancellor Reeves has locked herself into strict fiscal rules to avoid another Truss-style debacle. But yields are still near 30-year highs, signaling markets don’t buy the math. Borrowing is up, revenues underperform, and policy paralysis risks becoming its own credibility trap. The humiliation of an IMF-style rescue isn’t far from traders’ minds. France is drifting in its own way—€3 trillion in debt, deficits over 5% of GDP, and politics in turmoil. Bond spreads against Germany are widening toward crisis levels. Ratings agencies are circling. Paris risks being priced like Italy, not like a core eurozone sovereign. For Europe, that would be a seismic shift. The bigger point is clear: markets now demand a premium when trust in institutions erodes. Elevated yields aren’t a temporary inflation response. They’re a structural repricing of credibility. That means higher funding costs, weaker growth, and more volatility ahead. Credibility, once lost, is brutally expensive to buy back. For more, see our Nomura CIO Corner: https://lnkd.in/e4TCax_g #Markets #Bonds #Investing #Policy #CIOPerspective

The surprising fact about bond returns: In a study published in 2014, Marty Leibowitz, Anthony Bova, and Stanley Kogelman show that returns for the Barclays U.S. Government/Credit Index have consistently converged towards the index's initial yield-to-maturity. Over their study period, the index has had a relatively constant duration of about six years – consistent with the time horizon they used to measure convergence. Therefore, historically, the simplest of the rules of thumb seems to have prevailed: returns have converged to the initial yield-to-maturity at a time horizon that matches duration. This result holds across a variety of rate paths. It begs the question: why are bond investors and financial commentators in the media so worried about rising rates? If the horizon is long enough, it doesn’t matter whether rates go up, down, or sideways. What matters is the starting yield! (From Beyond Diversification, McGraw-Hill. The paper I'm talking about is: Leibowitz, Martin L., Anthony Bova, and Stanley Kogelman. 2014. "Long-Term Bond Returns under Duration Targeting", Financial Analysts Journal, Volume 70, Number 1, pp. 31–51.)

The Term Premium: A Subtle Force Behind Balance Sheet Risk The term premium is one of the most overlooked forces in balance sheet management. It affects the shape of the yield curve, the pricing of fixed income products, and the valuation of long-term assets and liabilities. And yet, it often receives little attention in day-to-day treasury or ALM discussions. Understanding the term premium—and how it moves—is beneficial for making realistic decisions about hedging, lending, and investment strategies. When misunderstood, it can distort the bank’s duration positioning, mislead IRRBB assessments, and affect commercial pricing. Here are three reasons why the term premium matters more than many assume: 1. The yield curve is not just about rate expectations Many interpret the yield curve purely as a signal of future interest rates. But in reality, it reflects two components: expected future short-term rates and a term premium. The term premium compensates investors for the risk of holding long-term securities in an uncertain environment. If the term premium is negative—common in recent years—long-term rates may be lower than short-term expectations suggest. Relying solely on forward curves without considering the term premium can lead to flawed duration and hedging decisions. 2. Term premium affects the valuation of structural hedges Structural hedging often involves placing long-term fixed-rate swaps or purchasing long-duration bonds. If the term premium is compressed or negative, those instruments may be priced tightly, offering little compensation for long-term risk. This makes structural hedging more expensive and increases mark-to-market sensitivity. A realistic understanding of the term premium helps treasury teams calibrate hedge sizing, tenor, and timing more effectively. 3. A changing term premium shifts IRRBB and FTP dynamics When the term premium rises—due to inflation fears, fiscal uncertainty, or reduced central bank intervention—long-term funding becomes more expensive, even if policy rates are stable. This shifts the FTP curve, affecting product pricing and business line behaviour. A rising term premium can also steepen the EVE sensitivity profile, exposing the bank to value erosion unless hedges are adjusted. Without active monitoring, these shifts can quietly embed risk into the balance sheet. So how should banks account for the term premium? It starts with awareness. Treasury and ALM teams should monitor market signals—swap spreads, long-term bond yields, and central bank activity—to estimate the implied term premium. While it is not directly observable, various market-based estimates can provide useful reference points. From there, it should be incorporated into hedging strategy, FTP calibration, and scenario analysis. This allows for more grounded expectations of long-term rate moves, helping to avoid over-hedging or mistimed duration positioning.