The bond market’s performance in 2022 was historically bad. For example, Vanguard’s Total Bond Market Index (US) was down -13.25% while the S&P Australia Aggregate Bond Index was down -10%. However, just like a bottle of good champagne on New Year’s eve, bond markets have popped so far in 2023. Just check out these rising US 3-month treasury yields.
Rising yields and issuance
2022’s rising inflation ambushed bond markets and sent prices of existing bonds plummeting. Bonds issued before the rise of inflation, with their lower coupons, were no longer attractive.
“Inflation is, in short, “kryptonite” for bonds.” Edward F. McQuarrie, professor emeritus, Santa Clara University.
However, now that we are on the other side of the unexpected inflation shock, bond investors are benefiting from the higher coupons. Our chart of the month above shows the rise in yield for 3-month Treasury bills. These levels have not been seen since before the 2008 GFC!
As a result of rising coupons, global bond sales have busted out of the gates so far in 2023. The first chart below shows that the global bond market has had its best start in over ten years - over USD 600bn has already been issued.
The second chart shows that the strong start is even more impressive in the emerging markets space, where the total value of debt issued to date is over 3x the 2022 amount. Many issues have reportedly been well oversubscribed.
Issuers from countries like Saudi Arabia ($10bn), Hungary ($4.25bn), and Indonesia ($3bn) are returning to the market after a turbulent second-half of 2022. It was hard to issue debt when inflation and interest rates kept rising. Now issuers are taking advantage of the inflection point in inflation and returning investor appetite.
Investors in these emerging market bonds are reaping the higher yields in expectation that the interest rate cycle of central banks are nearing their peak. Recent caution has been sacrificed in the face of opportunity.
This embrace of higher yields is also spilling over to the private debt space. A number of US private debt funds have recently raised funds with Australian superannuation funds. In total Australian super funds are believed to hold around AUD 30bn in private debt.
There are also opportunities for smaller investors to take advantage of the growing private debt funds in Australia. As rates have been rising and banks exercise caution and leave the small to medium company space, Australian private debt is becoming more attractive. Of course, investors will also need to watch loan performance if a recession occurs and if it turns nasty.
“Private credit is a place people can go to benefit from rising rates,” Jonathan Armitage, chief investment officer of Colonial First State.
The big banks in the US are not joining the issuing party though. They saw the higher yields coming and issued much of their bonds earlier in the year. They are expected to be circumspect this year, particularly after coming off some bad Q4 results, and with more pain expected.
Falling yields for 10-year treasuries and inversion
While yields have been rising at the short-end of the yield curve, US and Australian 10-year treasuries have been falling. Further, the inversion of the US yield curve has been increasing (the negative spread between the 10-year and 3-year) and is now at the highest level in over 40 years. The market is convinced an economic slowdown is coming soon and that rates will need to be cut. However, the inversion is great news for holders of 10-year treasuries who are enjoying a nice price rally at the start of the year.
It is also important to note that once inflation is tamed and interest rates and yields start to fall, the price for the bonds being bought now will rally later in the year. So whether you are looking to hold a higher coupon bond or are looking to sell it later in the year, you are in a good place. Bonds are looking up in 2023.
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