Income Plus Strategy

Janet Rilling: Welcome to the third quarter fixed income recap. During the quarter, bond markets delivered strongly positive total returns as a sizable rally in rates and the steepening of the yield curve led to bond prices that went higher. Investors saw a range of results depending on their allocation across the yield curve and the quality makeup of their portfolio. Broadly, bonds with more duration or, in other words, those that are more sensitive to changes in interest rates, and those with lower quality ratings outperformed bonds of higher quality or those with shorter duration. Yields fell and spreads, which is the additional compensation investors earn for bearing credit risk, mostly narrowed. A leading driver of the move in rates was the U.S. Federal Reserve, also known as the Fed, which began its rate cutting cycle and ended the higher for longer era in which bond markets have been trading for several quarters. U.S. economic data remained resilient and inflation continued to ease, giving the Fed confidence to implement a more aggressive 50 basis point (100 basis points equal 1%) cut to the Fed funds rate to start the easing cycle. There was a brief risk-off episode in early August, which was short-lived, but demonstrated that investors are still a bit on edge about the path of the economic cycle. The Fed joined other developed market central banks, such as the Bank of England, the European Central Bank, and the Bank of Canada, who had all lowered their main monetary policy rate in the second quarter. While there are outliers, such as Japan and Brazil who recently raised rates, this puts the United States in better sync with many central banks, who are moving to lower the restrictiveness of their policy rates. We believe this more synchronized global rate easing should offer some support to much of the global economy and allow recessionary risks to ease. That bodes well for the fundamental outlook. Demand for income continues to be very strong. Issuance in the investment grade and high yield corporate bond markets are at record levels in 2024, offering a strong technical support for investors. That leaves bond investors with supportive fundamentals and technicals, but valuations are stretched. Bond yields are lower than where they were a year ago, but relative to most of the last 15 years, they remain elevated. The income potential afforded through the public global fixed income markets is extremely high. Credit spreads, however, are very tight or low. Investors are getting paid less today to take credit risk in U.S. investment grade or high yield corporate credit than they have for nearly all of the last 15 years. Our outlook expects that the Fed will continue to ease policy, but we expect a more gradual rate cutting path, which implies that yields will remain somewhat elevated. We continue to see this as a good environment to source high-quality, broadly diversified income. That has led us to position portfolios with a neutral duration posture and to find opportunities to earn carry while moving up in quality and reducing our exposure to lower-rated sectors where valuations have gotten extreme. We have positioned our U.S investment grade credit allocation towards the low end of our neutral range and we remain underweight U.S. high yield exposures relative to past positioning. We modestly shifted plus sector exposures in the third quarter by taking advantage of the volatility in early August through a small increase in U.S. high yield bonds and European high yield corporates. And we added to our high-quality liquid exposures in global government bonds as U.S. yields fell. We believe rate and spread volatility will persist. We have built optionality into portfolios and have moved modestly up in quality. We'll look to tactically exploit opportunities through timely adjustments to positioning, using our multiple levers based on our six-month outlook and an unbiased approach. Thank you for your time and please reach out to your Allspring Global Investments contact if you have any questions about anything we discussed or would like some additional information.