Could rates fall in late 2023, despite the Fed's current hawkish rhetoric? Investors expecting continued volatility are looking to ultra-short bonds to de-risk portfolios, as short-term yields have risen much faster than long-term yields.
The S&P 500® Index ended the first week of the new year in positive territory, registering its best one-day return (+2.28%) since November 30, 2022. The yield spread between the US 10-year and 2-year Treasurys fell 14 basis points (bps) last week to -69 bps — and now hovers near a 10-year low.
In a surprise move, China is pausing its investment in homegrown semiconductors.1 This comes after disappointing results in building a rival to the US chip industry and COVID-19’s resurgence across the country.
The next UK GDP print is forecasted to show a slight contraction (0.1%) for November. Economists are projecting a mild recession this year.
The ISM Services Index fell below 50 last week (lower than the consensus estimate of 55.5) for the first time since the onset of the pandemic, a sign that the economy is weakening. In another indication of contraction, both Amazon2 and Salesforce3 have announced layoffs, adding to the recent wave of tech sector job cuts.
And Q4 earnings for the S&P® 500 Index are expected to fall 4.1%, according to FactSet, just as banks begin to report results at the end of the week.4
December’s Federal Reserve (Fed) meeting minutes reiterated the central bank’s hawkish stance, signaling that it does not intend to loosen policy until inflation declines further.5 Investors looking for additional cues on Fed policy may want to watch the year-over-year US CPI figure; November’s print is projected to decline to 6.5%.6
Amid the turmoil of 2022, many investors turned to ultra-short bond ETFs to de-risk portfolios. The category amassed $57 billion in net inflows last year, eclipsing its 2018 calendar-year high of $49 billion.7 Yet broad investment-grade and high yield credit spreads currently below their 20-year averages suggest credit is still richly valued, despite falling 15.7% and 11.2% last year, respectively.8
Expect continued volatility in capital markets, spurred by a disconnect between investors and the Fed over the path of interest rates. Despite the Fed’s sustained hawkish rhetoric in the most recent meeting notes, Fed funds futures imply that rates could fall in the second half of the year.9
Short-term yields have risen much faster than long-term yields as rate hikes have not been felt equally across the maturity curve. As a result, the actively managed SPDR® SSGA Ultra Short Term Bond ETF (ULST) has become an increasingly attractive alternative to longer duration and higher credit risk bond exposures. As seen below, ULST generates similar income as core bonds (4.53% versus 4.61%)10 while exhibiting 88% less volatility.11
ULST’s active approach has produced consistent results, both on a total return and risk-adjusted return basis. It ranks in or near the top quartile of its ETF and mutual fund peers over the trailing 1-, 3-, and 5-year periods, having outperformed its peer group median by 70 bps in 2022.12 The fund’s 0.84% return for 2022 ranked in the 23rd percentile for ultra-short investment-grade actively managed funds.13
ULST Offers Comparable Yield to Core Bonds with 88% Less Volatility
ULST Standard Performance as of December 31, 2022
1 Bloomberg Finance, L.P., as of January 4, 2023.
2 Axios, ‘Amazon to cut 18,000 jobs,’ as of January 4, 2023.
3 CNN, ‘Salesforce to cut about 10% of staff,’ as of January 4, 2023.
4 FactSet Earnings Insight, as of January 6, 2023.
5 Bloomberg Finance, L.P., as of January 4, 2023.
6 Bloomberg Finance, L.P., as of January 6, 2023.
7 Morningstar, as of December 31, 2022.
8 Bloomberg Finance, L.P., as of December 31, 2022. Investment grade represented as the Bloomberg US Corporate Bond Index. High yield represented as the Bloomberg US Corporate High Yield Index. Current investment-grade credit spread is 130 bps versus its 20-year average of 149 bps. Current high-yield credit spread is 469 bps versus its 20-year average of 505 bps.
9 Bloomberg Finance, L.P., as of January 5, 2023. FOMC projection of 5.13% is based on the median dot plot value.
10 Bloomberg Finance, L.P., ssga.com, as of January 5, 2022. Core bonds represented as the Bloomberg US Aggregate Bond Index. SEC yield used for ULST. Yield-to-worst used for core bonds.
11 Morningstar, as of December 31, 2022. Core bonds represented as the Bloomberg US Aggregate Bond Index.
12 Morningstar, as of December 31, 2022. Peer group defined as US-listed ETFs and US-domiciled mutual funds (oldest share class) in the Ultrashort Bond Morningstar Category. Risk-adjusted return measured by Sharpe Ratio.
13 Morningstar, as of December 31, 2022.
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