In this article, we review:
- December data that shows the U.S. economy continuing to chug along
- The absence of a Santa Claus rally, and what that meant to credit spreads
- The performance of short duration, core bonds, high yield, and floating rate bank loans, and emerging market debt
Macro & Rates
Data releases showed the economy continued to chug along in December. The consumer price index (CPI) rose 0.3% in November from the previous month. On a year-over-year basis, the CPI moved up to 2.7% from 2.6% in October. Overall, the final GDP reading came in at 3.1% in the third quarter, as consumer spending continued to be the largest contributor to growth.
Payroll data showed the economy added 227,000 jobs in December, a bit higher than the 200,000 jobs economists expected. Meanwhile, the unemployment rate, which is based on a separate survey, ticked up to 4.2% in November from 4.1% the previous month.
Investors continued to keep a close eye on interest rates. The Federal Reserve cut its benchmark fed funds rate 25 basis points (bps) to between 4.25% and 4.50% at its December meeting. But Fed Chairman Jay Powell also said that going forward the Fed is going to be “cautious about further cuts.”
Net change in U.S. nonfarm payrolls
In thousands, seasonally adjusted
Sources: U.S. Bureau of Labor Statistics, Moody's Analytics. Data as of January 2025.
Short Duration
Short-dated credit spreads underperformed during the month, as credit curves flattened while Treasurys steepened. The Ice BofA 1-3yr US Corporate Index ended December 4 bps wider at a 56-bp option-adjusted spread. December primary supply came in on the lighter side compared to the seasonal run rate. But light liquidity and expectations of a lot of issuance in January kept investors sidelined. The index posted excess returns of -2 bps, but still generated a 0.22% total return, as elevated levels of carry offset the shift higher in yields.
Core Bonds
The Santa Claus rally many expected didn’t materialize and credit spreads drifted modestly wider during the month of December. The Federal Reserve’s Summary of Economic Projections showed the rate-setting only expects two cuts in 2025, compared to the expectation of four back in September. The Fed also bumped up its expectation for core PCE to 2.5% from 2.2%. Treasury yields moved markedly higher in a bear-steepening manor, with the 30-year Treasury finishing December 42 bps higher at 4.78%.
Credit had a strong first half of the month, as primary supply slowed and investors continue to have cash to put to work. The Bloomberg US Credit index briefly reached an option-adjusted spread of 71 bps, before grinding wider, along with other credit assets, with the rise in rates and equity volatility. U.S. investment-grade new issuance totaled $34 billion, which was below the seasonal run rate of $50 billion. The Bloomberg US Investment Grade Credit index ended the month 3 bps wider at 77 bps, which resulted in a monthly excess return of -4 bps and total return of -1.89%.
January will feature a very heavy primary calendar, with current estimates of between $175 billion and $200 billion. However, heavy supply does not necessarily mean wider spreads, as evidenced by January 2024’s performance that saw spreads end tighter with $190 billion worth of issuance. That said, the starting point of spreads is now very different, with the index starting at a +77 option-adjusted spread compared to +93 this time last year.
High Yield
The high-yield market declined in December as the Fed’s hawkish rate cut prompted a sell-off across risk assets. Despite a quiet start to the month, volatility returned as Powell surprised markets by indicating a more gradual path for rate cuts. The cautious commentary and hawkish tone led to weakness across the equity and rate markets. The 10-year U.S. Treasury yield shot up over 40 bps during the month and ended the year at around 4.5%. Against that backdrop, the high-yield market experienced its first meaningful sell-off in weeks. Although this was mainly driven by ETFs and systematic trading, the selling came at a time when the market was already rather illiquid around the holiday season.
For the month, the Bloomberg US Corporate High Yield Index returned -0.43%, bringing the year-to-date return to 8.19%. Within the index, BBs bore the brunt of the pain in December as longer-duration bonds faced headwinds given the rate moves. BBs returned -0.65% followed by B-rated bonds at -0.31%. Meanwhile, CCCs managed to deliver a small gain of 0.09% during the month. As rates rose and spreads widened, the yield to worst on the index increased to around 7.5% as of December 31.
In terms of market technicals, new issuance was light in December, as anticipated, with around $12 billion of new high-yield bonds pricing. On the demand side, flows turned negative amid the broader risk-off tone.
Floating Rate Bank Loans
The loan market largely chugged sideways in December, with the S&P UBS Leveraged Loan Index ending the month down 3 cents at 96.37. After grinding higher on price for many months, the index finally stalled out, as re-pricing risk capped higher dollar-priced loans around 101 and certain lower-quality names gave some price back during the month as managers de-risked a bit going into year-end. This was especially true for CLOs going through reset transactions that needed to reduce CCC loans.
In addition, a back-up in bond yields and reduced expectations for Fed rate cuts permeated the market in December, resulting in fewer tailwinds for unhedged, floating-rate capital structures. So that market dynamic was being priced into certain credits as well.
However, the solid coupon still resulted in a positive 58 bps return in December and the S&P UBS Leveraged Loan Index finished with an 8.93% return for the year. The 3-year yield stood at 8.79% at the end of the year, a full 30 bps higher than at the end of November, largely due to the higher-for-longer rate expectations.
Primary continued to be strong in early and middle part of the month, although the calendar remained littered with re-pricing transactions, with some new-money deals and re-financings sprinkled within. Third-quarter earnings season for some late filers also wrapped up during the month and largely mirrored the equity markets in that companies continued to perform decently, albeit with a cautious tone and some slowing in the more industrial- and construction-related segments of the economy.
Loan funds were largely flat in December, as inflows early in the month were offset by outflows later in December, but the market impact was muted overall. CLOs finished 2024 in style with another strong issuance month for all flavors of broadly syndicated loan CLO issuance — new deals, resets and re-financings — as equity sponsors and managers took full advantage of the lower CLO liability spreads to lock in cheaper financing for the various structures.
Emerging Markets Debt
Despite a Fed-induced wobble pre-Christmas, emerging market debt spreads still tightened during December by roughly 10 bps due to further CCC outperformance. Performance in BB-rated and above credit was more mixed (0 to 4 bps wider) but reflected the already low spread levels in much of the market.
The Fed’s revisions to 2025 expectations for policy rates and inflation and the subsequent strength of the dollar were ultimately insufficient to offset December’s positive developments in geopolitics and debt restructurings. Lebanon (+40% in December) surpassed Argentina as the year’s top performer as the fall of Assad’s regime lifted bond prices and the list of foreign actors interfering in Lebanese domestic politics shrank further.
Ukraine (+4.6%) was another beneficiary of geopolitical developments as Trump’s return to office fueled speculation of de-escalation in that conflict. Sri Lanka completed its long-anticipated debt restructuring, following in the footsteps of Ghana, Ukraine, and Zambia in a successful year for debt resolutions. That provides the asset class with a cleaner headline credit spread entering 2025.
Meanwhile, activity in the (stressed) debt-for-nature market continued, with Ecuador’s bonds lifted by a tender to funded by a new deal for Amazonian conservation. One lingering worry in 2024 was realized in December as both Brazil and Romania underperformed the market as the lack of fiscal consolidation in their respective markets came to the fore. The Brazilian real was already under pressure prior to the Federal Reserve meeting as its Congress further watered down an austerity bill aimed at reining in a 10% fiscal deficit. The real was the worst-performing major emerging market currency in 2024.
The asset class returned -1.4% in December due to the upward shift in the U.S. Treasury curve but returned 6.5% for 2024 overall. Outflows from hard currency funds in December were $5.1 billion, bringing the 2024 total to approximately $19 billion.
Past performance is not indicative of future results. It is not possible to invest directly in an index, which also does not include the application of fees. Yield to worst (YTW) is a measure of the lowest possible yield that can be received on a bond that fully operates within the terms of its contract without defaulting.
Sub-Adviser Page
Index Definitions
The 10-Year U.S. Treasury bond is a U.S. Treasury debt obligation that has a maturity of 10 years.
The Bloomberg Emerging Markets Aggregate Index measures the performance of hard currency Emerging Markets (EM) debt, including fixed and floating-rate U.S. dollar-denominated debt issued from sovereign, quasi-sovereign, and corporate EM issuers.
The Bloomberg US Aggregate Bond Index is an unmanaged index used as a general measure of market performance.
The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market.
The Bloomberg US Corporate Index measures the investment-grade, fixed-rate, taxable corporate bond market.
The Bloomberg US Government Bond Index is comprised of the U.S. Treasury and U.S. Agency Indices. The index includes USD-denominated, fixed-rate, nominal U.S. Treasurys and U.S. agency debentures (securities issued by U.S. government-owned or government-sponsored entities, and debt explicitly guaranteed by the U.S. government).
The Credit Suisse Leveraged Loan Index tracks the investable market of the U.S. dollar-denominated leveraged loan market.
The ICE BofA 1-3 Year US Corporate Index, a subset of the ICE BofA US Corporate Master Index, tracks the performance of U.S. dollar-denominated, investment-grade-rated corporate debt publicly issued in the U.S. domestic market. This subset includes all securities with a remaining term to maturity of less than 3 years.
Past performance is not indicative of future results. It is not possible to invest directly in an index, which also does not include the application of fees.
Important Information
All opinions, estimates, projections, and security selections contained herein are those of the sub-adviser. It does not constitute investment advice and should not be used as a basis for any investment decision.
Fixed income securities are subject to risks including credit risk, interest rate risk, counterparty risk, prepayment risk, extension risk, valuation risk, and liquidity risk. The value of fixed income securities generally goes down when interest rates rise, and therefore the value of your investment in the fund may also go down. High-yield bonds tend to be volatile and more susceptible to adverse events, credit downgrades, and negative sentiments. Changes in interest rates, the market's perception of the issuers and the creditworthiness of the issuers may significantly affect the value of the Fund.
The risks of investing in foreign securities are magnified in emerging markets. Foreign and emerging market investments involve risks not associated with U.S. markets, such as currency fluctuation, adverse social and political developments, and the relatively small size, lower trading volumes and lesser liquidity of the markets.
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