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Bond markets strongly positive as Fed begins cutting
A much-anticipated Fed cutting cycle begins
David Bradin
Investment director
Catherine Magyera
Investment product manager
Key takeaways for the quarter ended September 30, 2024
- In the third quarter, fixed income markets were positive as the long-awaited start of the U.S. Federal Reserve (Fed) cutting cycle began in September. The yield curve shifted out of the inverted position (where short-term interest rates are higher than long-term rates), although it still remained at near historically flat levels. High-quality credit and longer duration delivered some of the highest returns for the quarter.
- Over longer term periods, the majority of fixed income American Funds (Class F-2) 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).*
Inflation took a backseat to a softer labor market as the U.S. Federal Reserve (Fed) cut their target rate to support economic growth despite mixed economic data early in the third quarter. A weaker-than-expected July non-farm payroll number and an unwind of the Japanese yen carry (interest income) trade contributed to a market selloff in early August; however, subsequent U.S. data painted a more balanced picture. While the pace of job growth, inflation and economic activity slowed, growth remained net positive. Treasury yields fell substantially as the Fed ultimately delivered a 50-basis point (bps) rate cut — its first in this cycle. Risk assets rallied, with equities hitting new all-time highs, while credit spreads across most fixed income sectors remained tight. The Bloomberg U.S. Aggregate Index returned 5.20% for the quarter.
The Treasury yields that occurred in anticipation of the Fed cut in September ended the longest running yield curve inversion in recorded history. The spread between 2-year and 10-year Treasurys (“2s-10s”) finished the quarter at 14 bps, which while positive for the first time in nearly two years, remains in the bottom quartile of historical levels and is notably flatter than its 50-year average. The 2-year, 5-year, 10-year and 30-year Treasury yields decreased 111 bps, 82 bps, 62 bps and 44 bps, respectively. The 10-year Treasury yield ended the quarter at 3.78% and the 2-year Treasury yield ended the quarter at 3.64%. The focus for rates markets is the extent of cuts by year-end and into 2025, something likely to be driven by the health of the labor market. Fed governors have penciled in an additional 50 bps of cuts for 2024, followed by an additional 100 bps of cuts in 2025.
Inflation data continued trending lower while the labor market softened. The Consumer Price Index rose at an annualized 2.5% in August, down from 3.0% at the end of June 2024, and 3.4% at the end of 2023. Core inflation, which excludes food and energy, fell to 3.2% from 3.3% in June 2024. Meanwhile, the unemployment rate stayed relatively flat throughout the quarter, albeit at a heightened level from the prior year.
Credit spreads across high-yield and investment-grade (BBB/Baa and above) markets modestly tightened this quarter. Investment-grade credit spreads ended the quarter at 89 bps over Treasuries, tighter by 5 bps compared to the previous quarter-end. High-yield credit spreads ended the quarter at 295 bps over Treasuries, tighter by 14 bps from June 30, 2024. The yield to worst on the Bloomberg U.S. Corporate High Yield Index was 6.99% as of the end of September.
Sources: Bloomberg Index Services Ltd., RIMES. As of 9/30/24. Past results are not predictive of results in future periods.
Source: Bloomberg Index Services Ltd. As of 9/30/24. Past results are not predictive of results in future periods.
U.S. fixed income markets strongly positive in the third quarter amidst a more constructive backdrop for growth, falling inflation and Fed rate cuts.
U.S. bond market returns were strongly positive for the quarter. High-quality corporate credit delivered the strongest results. The Bloomberg U.S. Aggregate Index, which represents the broad bond market, returned 5.20%. Securities with longer duration generally outpaced their shorter duration counterparts amidst a significant Treasury yield rally. Duration indicates a bond fund’s sensitivity to interest rates; generally, lower duration indicates less sensitivity.
All 27 of our fixed income mutual funds and ETFs had positive absolute results for the quarter. In terms of benchmark relative results, 24 of our 27 fixed income mutual funds and ETFs delivered results in line (within 10 bps) or ahead of their primary benchmarks. Generally, funds with longer duration benefited as yields fell. And while credit spreads only modestly tightened, exposure to corporate credit was also generally additive.
Anchoring your portfolio with disciplined fixed income mutual funds and ETFs
In response to what appears to be more resilient economic growth, moderating inflation, and a significant decrease in Treasury yields, we believe a disciplined approach to overall portfolio construction will remain critical. As a result, we look to construct portfolios that reflect balanced risks across excess return drivers and diverse macroeconomic outcomes. Broadly, fixed income can 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 20 bps, 93 bps and 41 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 a low 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 (157 bps).
CGCP — Capital Group Core Plus Income ETF can help anchor a portfolio while pursuing a consistent income. CGCP (market price) outpaced its primary index, the Bloomberg U.S. Aggregate Index, by 16 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, aimed at generating 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 (77 bps), 3-year (34 bps), 5-year (23 bps) and 10-year (13 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.
CGMU — Capital Group Municipal Income ETF 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 34 bps for the quarter. The fund’s investment objective is to provide a high level of current income exempt from regular federal income tax, consistent with the preservation of capital.
American Funds Multi-Sector Income Fund (MIAYX, Class F-2) outpaced its blended benchmark over the 3-year (91 bps) and 5-year (150 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.
CGMS — Capital Group U.S. Multi-Sector Income ETF is an option for investors seeking a higher income bond allocation. CGMS (market price) trailed its primary index, the Bloomberg U.S. Aggregate Index, by 32 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: Positioning for a steeper yield curve continues to look attractive from a valuation perspective as the belly (middle) of the curve remains rich (more expensive than other areas) even as most of the curve is now positively sloped. Given that the Fed has begun cutting rates and Treasury yields have decreased meaningfully, the curve steepener remains the primary risk-off hedge to complement risk exposures elsewhere. The curve should also become steeper over time even without a risk-off event as we believe the front-end falls due to rate cuts while the long end rises due to concerns about Treasury supply or federal deficits.
- Diversified exposure across select credit sectors should benefit from a more constructive backdrop where growth remains positive, inflation is falling and the Fed is cutting rates. We believe credit fundamentals are sound, and while spreads may not compress further, they are likely to remain stable. Structured credit and emerging market debt appear relatively more attractive than investment-grade corporates. In our view, the shorter duration, improved credit quality and higher carry of U.S. high-yield market make it attractive in the current economic backdrop.
- Mortgage-backed securities: seeking select exposure as the sector has rallied. Valuations suggest a reduced allocation, but the sector remains beneficial from a liquidity perspective, especially for managers who focus on coupon selection.
We believe there are multiple areas of opportunity within fixed income markets as markets digest the magnitude of rate cuts for the rest of the year and into 2025. 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.
Fund results and analysis
All mutual fund returns are for Class F-2 shares unless stated otherwise.
Results as of September 30, 2024. Figures shown are past results and are not predictive of results in future periods. Current and future results may be lower or higher than those shown. Investing for short periods makes losses more likely. Share prices and returns will vary, so investors may lose money. Refer to fund expense ratios and returns. View ETF expense ratios and returns.
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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. Bloomberg U.S. MBS Index is the U.S. MBS component of the U.S. Aggregate Index. The MBS Index covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC).
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