Macro Talking Points - Week of 27 November 2023

by Benoit Anne Lead Strategist, Investment Solutions Group, MFS Investment Management

Global fixed income market analysis through a macroeconomic lens.

In brief

• Plenty of relative value opportunities in fixed income
• Market seems to be getting Fed pricing right
• Some solid YTD performance for fixed income segments

Volatility creates relative value opportunities. With volatility usually comes market dislocation, which can offer opportunities for active asset managers. This holds true in global fixed income, especially when looking at relative value (RV) across markets. A fixed income manager with a global mandate can exploit valuation dislocations across countries, sub-asset classes, regions and even currencies, among other typical alpha levers. Looking at our relative value screener, some interesting opportunities jump out. Let’s start with Canada investment-grade, which now trades at a considerable discount to its US peer. The credit spread differential between Canada and US IG now stands at +37 bps, corresponding to a RV z-score of 2.36, a significant statistical signal.¹ This is a particularly attractive RV level given that the duration of the Canadian IG index is markedly shorter than that of the US. In other words, the RV is even more attractive in favor of the Canada index on a duration-adjusted basis. A big part of this story is that US IG spreads look stretched now. US IG spreads currently trade at 109 basis points, their lowest level since February 2022. Unsurprisingly, the difference between the relative value of European IG and US IG also looks interesting. European IG trades 39 bps wide of its US counterpart, for a relative value z-Score of 1.71, a sizable gap, although it was even higher a few months ago.² In emerging markets, EM corporate IG valuation looks very attractive at this point against EM sovereign IG, but it is the opposite in EM high yield, with EM sovereign HY considerably cheaper than EM corporate. Being an active manager is all about managing the risks and taking advantage of the opportunities, and there seem to be plenty of them these days in global fixed income.

Adequate market-implied Fed pricing. There is no major discrepancy between the market-implied pricing of US Federal Reserve policy and what the Fed is likely to do at this point, an unusual occurrence. Obviously, making Fed policy calls has been a dangerous game recently, but one plausible scenario is gradual rate cuts by midyear. In total, there are 75 bps of cuts priced in for 2024 by the federal funds futures curve, which sounds about right.³ The Fed is making it clear that, events notwithstanding, it is data-dependent, and when the Fed says data-dependent, it really means is talking about inflation data. The central bank has paid little regard to growth dynamics, especially as a severe recession appears less likely. Core PCE — the inflation measure favored by the Fed — is on a downward trajectory, but at 3.7%, it remains too high.⁴ A decisive breakthrough below 3.5% would allow the Fed chair to breathe a sigh of relief, an upgrade from recent expletives. It looks likely we will get there, which should solidify the attractiveness of fixed income as the disinflation story will promote the normalization of rate volatility.

Closing the books. With Thanksgiving now behind us, investors are slowly transitioning into pre-holiday mode. Though it has not been the year we had hoped for in global fixed income so far, some asset classes have done quite well. This is particularly the case for EM local currency debt, which has come out on top with year-to-date performance of 9.47%, almost a double-digit return despite a challenging macro environment.⁵ Global HY and US HY have also performed strongly, with returns both north of 8% year to date.⁶ Elsewhere, a special prize goes to European IG in the investment- grade category, with a robust 4.16% year to date.⁷ European credit continues to be attractive, both from the valuation and the fundamental standpoints. At the other end of the spectrum, it has been a tough year for Agency mortgage-backed securities and US Treasuries, which have so far registered modestly negative returns. The outlook for MBS has improved considerably, however, and in fact the MBS month-to-date performance so far in November has been well above 3%. Going forward, the end of the Fed tightening cycle is the game changer we all have been waiting for, and we think the future looks brighter for fixed income.

Endnotes

¹ Sources: Bloomberg. Canada IG = Bloomberg Canada Aggregate Corporate Total Return Index. US IG = Bloomberg US Corporate Bond Index. Data as of 24 November 2023. A z-score is a measure of deviation from long-term average in terms of unit of standard deviation. A z-score above 1 is typically considered to indicate an attractive level.
² Sources: Bloomberg. EUR IG = Bloomberg Pan-Euro Aggregate Corporate Total Return Index. Data as of 24 November 2023. A z-score is a measure of deviation from long-term average in terms of unit of standard deviation. A z-score above 1 is typically considered to indicate an attractive level.
³ Sources: Bloomberg. Based on the Fed fund futures curve up to Dec. 2024. Data as of 24 November 2023.
⁴ Sources: Bloomberg. US Personal Consumption Expenditure Core Price Index YoY. As of September 2023.
⁵ Sources: Bloomberg, J.P. Morgan. Data as of 24 November 2023. EM Local debt = JPMorgan GBI-EM Diversified USD
⁶ Sources: Bloomberg, Global HY = Bloomberg Global HY index. US HY = Bloomberg US HY index. Data as of 24 November 2023.
⁷ Sources: Bloomberg. EUR IG = Bloomberg Pan-Euro Aggregate Corporate Total Return Index. Data as of 24 November 2023.

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The views expressed herein are those of the MFS Investment Solutions Group within the MFS distribution unit and may differ from those of MFS portfolio managers and research analysts. These views are subject to change at any time and should not be construed as the Advisor’s investment advice, as securities recommendations, or as an indication of trading intent on behalf of MFS.