Bond markets: five influences in 2024
President, Fixed Income & Data Services
ICE
For bond traders, 2023 was an eventful year. The Fed signaled an end to its aggressive rate hike campaign to combat inflation. Volatility shook nerves amid bank stability fears and geopolitical risk. And for the yield-hungry, it offered some of the best opportunity in decades. As we look to the year ahead, what key influences could determine the direction of bond markets? Here are five we’re watching.
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Fed pivot
The start of 2024 paints a stark contrast to a year earlier for bond markets. Then, the Fed was part way through an aggressive rate hike cycle in a bid to combat high inflation - the peak of which would bring 10-year Treasury yields above 5%, their highest level since 2007. In December 2023, the Fed indicated a policy pivot, forecasting 75 bps of cuts during 2024. Now, we've noticed markets may be focusing in on the timing, pace, and depth of rate cuts - with repercussions for market sentiment, fund flows, and potentially the actions of other central banks. Among the questions which investors are pondering: what might a higher “new normal” for interest rates and/or structurally higher inflation mean for bond markets? And what might the combined fall in interest rates - magnified by a potential reduction in the Fed’s balance sheet - mean for markets?
Federal Reserve Assets Held (less eliminations from consolidation)
Source: Board of Governors of the Federal Reserve System (US)
Soft landing vs. recession
ICE BofA Distressed High Yield Index - Constituent Count
Whether the U.S. is headed for recession or a soft landing may be a question of data interpretation: inflation is falling but remains high, while the labor market is slow but steady - explosive job growth is gone, however broad-sector layoffs that often accompany a recession have not materialized. In this vein, jobs numbers and inflation will be key data points to watch for clues on economic health. Other unknowns: the lag effect of higher interest rates such as mortgage and business credit costs, and the potential for a sharper pullback in spending as inflation has a growing impact on consumption. Broadly, the World Bank expects a third year of slowing growth for the global economy, forecasting expansion of just 2.4% in 2024 - though it notes that the risk of a global recession has receded. What insights can we glean from the bond market? Looking at the ICE BofA Distressed High Yield Index, the number of issues trading at distressed levels has picked up only marginally since post-COVID lows, implying a relative comfort level exists among investors for the moment.
Geopolitical tensions
Conflicts like those in Ukraine and Gaza present both a humanitarian crisis, and a potential threat to global supply chains which provide crucial food and fuel. This was earlier highlighted by Europe’s energy crisis, with resulting sanctions and trade tensions that can impact businesses, commodity prices, economies, and global market sentiment. Uncertainty and the inability to predict how flareups will be resolved can manifest in increased market volatility. For U.S. bond markets, where the ICE BofA MOVE index entered the new year well above its long-term average, investors are already on edge and unlikely to welcome further spikes of volatility. As these conflicts continue, they could have significant impacts on relations between major powers like the U.S., Middle East, China, and Europe - with potentially destabilizing effects on risk appetites.
ICE BofA U.S. Bond Market Option Volatility Estimate (MOVE) Index
Mortgage rates and the housing market
ICE U.S. Conforming 30-Year Fixed Mortgage Rate Lock Index
Mortgage rates for 30-year, fixed rate loans hit a two-decade high near 8% last year (see chart), causing sales of existing homes to plummet as many homeowners opted to sit tight. While relief appears to be on the horizon - in the form of a Fed pivot - the timing of rate cuts may mean their full effect is not felt until late in the year. Still, falling mortgage rates should see more inventory come to market, as the gap between existing loan costs and those locked in during the low-rate era start to narrow. Since housing is a major contributing factor in the CPI calculation, it could offer further inflation relief through a softening of home prices. For the time being, a clear bright spot exists: the relative strength of the U.S. economy means there has been little forced selling to date, a dynamic which often marks recession.
Presidential election year
A polarizing election in the world’s largest economy could impact everything from U.S.- China relations and currency strength, to consumer sentiment and the pace of rate hikes. So how has fixed income historically fared during presidential election years? While it’s a complex question, one measure, the ICE BofA US Broad Market Index, has a higher total return on average when POTUS is on the ballot than when not, going back to 1976. More broadly, countries representing ~60% of global GDP will also have elections this year, including Taiwan, Germany and the United Kingdom. Elections can prompt a 'wait-and-see' attitude in markets, with their outcomes resulting in significant risk repositioning. In particular, Taiwan’s election could have broader effects - potentially fueling China’s desire to control the island democracy, and inflaming U.S.-China relations.
ICE BofA U.S. Bond Market Index - Total Return
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