2024 Bond Market Outlook: Midyear Update

In Brief

A moderation in inflation and rate-cut expectations along with resilient U.S. economic growth suggest both confidence in the U.S. Federal Reserve (Fed) and a low likelihood for meaningful policy shifts.
Credit, particularly short-term maturities, offer historically attractive yields in a continually supportive environment.
We believe a selective approach to idiosyncratic opportunities offered across credit segments could add value and balance to a fixed-income allocation.

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As we navigate to the back half of 2024, we remain constructive on fixed income as an area to generate attractive risk-adjusted total returns in investors’ portfolios. Our base case for optimism rests on both macro and fundamental factors, but live debates remain across the investing landscape requiring both a healthy dose of skepticism as well as humility. The most obvious tensions fixed-income investors need to contend with remain 1) probability weighting the various potential paths of monetary policy, 2) reconciling reasonably tight credit spreads in many sectors against historically attractive all-in-yields and 3) ensuring portfolio resiliency against a range of possible outcomes that could surface in the second half.

Focus Less on Cuts and More on Conditions

We can all recall that as recently as the start of 2024, consensus expectations were for the Fed to ease by almost 175 basis points (bps) this year. Today, that expectation has moderated significantly, down to just one or two eases of 25 bps given continued, but uneven progress towards the Fed’s inflation goal. Economic resiliency reigns despite monetary policy that would normally be considered reasonably restrictive. But we are seeing some evidence of both normalization from elevated levels in pockets of consumer spending and some softness in consumer segments particularly impacted by sticky inflation. Both realities are leaving benchmark rates moderately lower from their recent peaks. While data-dependency rings true with our investing teams, we consider a resumption of policy hikes a low probability event, but a key vulnerability to risk asset performance. The most definitive observation we can make is that inflation expectations remain generally well anchored, suggesting markets and consumers retain confidence in the Fed.

Carry Continues to Win with a Focus on Lower-Rated, Short-Term Maturities

Across strategies, we continue to lean into areas of credit—both securitized and corporate— where attractive yields potentially offer some measure of forward return predictability, even if we do not see meaningful spread tightening from here. And of course, we must always consider “what’s in the price?” For example, one of the leading areas of fixed income returns this year has been commercial mortgage-backed securities (CMBS). Many fundamental concerns remain, particularly in the office sub-sector, the overriding negativity in this space to start 2024 created viable opportunities now being captured. We believe many idiosyncratic opportunities to both gain and shed exposure remain across securitized products.

In the corporate space, the higher-for-longer environment has kept our start-of-year preference for short-dated and floating-rate exposure largely in place. Longer-dated, core bond exposures have a portfolio role. They include hedging against tail outcomes—a recessionary narrative as well as a quicker fall in inflation than we currently see. But a preferred approach includes bundling this exposure with front-end credit including short-duration high yield and bank loans that both take advantage of a still moderately inverted yield curve, manageable default expectations, all while potentially paying investors handsomely as we await further detail on the Fed’s direction (see Figure 1).

Figure 1. Higher Starting Yields May Create Opportunity for Stronger Forward Returns

Yield to worst on indicated indexes, December 31, 2020, and May 28, 2024

Source: Bloomberg and Credit Suisse. Data as of May 28, 2024. Indices: Bloomberg 2-year U.S. Treasury Index, Bloomberg 10-year U.S. Treasury Index, Bloomberg U.S. Aggregate Bond Index, Bloomberg U.S. Agency MBS Index, Bloomberg AAA-Rated U.S. ABS Index, Bloomberg U.S. Corporate Index, Bloomberg Non-Agency CMBS Index, Bloomberg U.S. High Yield Corporate Index. MBS=mortgage-backed security. CMBS=commercial mortgage-backed security. ABS=asset-backed security.

Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Due to market volatility, the market may not perform in a similar manner in the future. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

Preserving Portfolio Flexibility Given Ongoing Uncertainty

Investors may contend that the future is persistently unpredictable. The U.S elections this fall may further lead some investors to sit out markets until they gain greater clarity on the potential outcomes in both the legislative and executive branches. We believe this posture is a mistake. The record of financial markets properly calibrating ahead of elections isn’t particularly inspiring. And relative to the last two election cycles in 2016 and 2020, investors are faced with two presidential candidates with prior experience in the White House providing some argument for “known unknowns” as well as far less uncertainty than prevailed during the depth of the pandemic. Fixed income yields are far more attractive compared to those periods, providing prospective returns that could approach long-term equity return expectations. We remain steadfast in our belief that monetary policy will remain independent of politics and we have many levers to adapt to any reshaping of the yield-curve and post-election evolution of monetary policy. Our preferred exposure in either outcome remains credit as noted above, and while we’ve likely seen the peak of rate volatility, uncertainty premiums are likely to remain higher for longer in intermediate and long-duration exposures.

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About the Contributors

Steven F. Rocco, CFA

Partner & Co-Head of Taxable Fixed Income

Robert A. Lee

Partner & Co-Head of Taxable Fixed Income

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The credit quality of fixed-income securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.

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Glossary & Index Definitions

Carry is the difference between the yield on a longer-maturity bond and the cost of borrowing.

Duration is a measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates.

The Federal Reserve (Fed) is the central bank of the United States. The federal funds (fed funds) rate is the target interest rate set by the Fed at which commercial banks borrow and lend their excess reserves to each other overnight.

Spread is the percentage difference in current yields of various classes of fixed-income securities versus Treasury bonds or another benchmark bond measure. A bond spread is often expressed as a difference in percentage points or basis points (which equal one-one hundredth of a percentage point). The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Typically, an analyst uses the Treasury securities yield for the risk-free rate.

A basis point is one one-hundredth of a percentage point.

Yield is the income returned on an investment, such as the interest received from holding a security. The yield is usually expressed as an annual percentage rate based on the investment's cost, current market value, or face value.

The Bloomberg U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

The Bloomberg U.S. Agency MBS Index covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The MBS Index is formed by grouping the universe of over 600,000 individual fixed rate MBS pools into approximately 3,500 generic aggregates.

The Bloomberg AAA-Rated ABS Index is the AAA-rated ABS component of the Bloomberg U.S. Aggregate Index.

The Bloomberg Investment-Grade Corporate Index is the corporate component of the Bloomberg U.S. Credit index. It includes publicly issued, SEC-registered U.S. corporate debt.

The Bloomberg Non-Agency Investment-Grade CMBS Index includes non-agency CMBS securities that are eligible for the Bloomberg U.S. Aggregate Bond Index.

The Bloomberg U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt. Eurobonds and debt issues from countries designated as emerging markets (sovereign rating of Baa1/BBB+/BBB+ and below using the middle of Moodys, S&P, and Fitch) are excluded, but Canadian and global bonds (SEC registered) of issuers in non-EMG countries are included. Original issue zeroes, step-up coupon structures, 144-As and pay-in-kind bonds (PIKs, as of October 1, 2009) are also included.

The ICE BofA US High Yield Index tracks the performance of U..S dollar-denominated, below-investment-grade corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below-investment-grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one-year remaining term to final maturity

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