• Developed market bonds broadly rallied in July, as weaker economic data sent signals that central banks may cut interest rates.
  
  
• Government bond yields fell, with US 2- and 10-year Treasury yields declining by 50 bps and 37 bps, respectively.
  
  
• Investment-grade corporate bond spreads broadly tightened over the month, amid strong demand ahead of potential rate cuts. 

Developed market bonds broadly rallied in July, as softer economic data, particularly in the US, fuelled fresh hopes that central banks would cut interest rates.

In the US, weaker labour market data helped drive bond markets higher, as the unemployment rate rose to 4.3%. Wage growth and job creation figures also showed signs of softening.

Inflation data for June also showed signs of slowing. US headline and core inflation both surprised to the downside, falling to 3.0% and 3.3%, respectively. In the UK, headline and core inflation remained steady at 2% and 3.5%, respectively. In the euro area, headline inflation slowed slightly to 2.5%, with core inflation steady at 2.9%.

Despite the weaker signals, economic activity across major markets in June surprised to the upside, although growth in the UK and euro area remained well below pre-Covid-19 trends.

At their July meetings, the US Federal Reserve (Fed) left the federal funds rate unchanged at 5.25%-5.5% and European Central Bank (ECB) left its key interest rate at, citing persistent inflation. However, both said they remained confident that the US and euro area economies, respectively, were on sustainable paths towards inflation targets. Meanwhile, the Bank of England (BoE) announced its first rate cut of 25 bps at its 1 August meeting, its first rate cut since 2020, taking its Bank Rate from a 16-year high of 5.25% down to 5%. Elsewhere, the Bank of Japan (BoJ) raised interest rates by 15 bps and announced reductions in its bond-buying programme.

Monthly performance by market

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Source: Bloomberg, for the period 30 June 2024 to 31 July 2024. Calculations are monthly total returns, in USD. Indices used as proxies of market performance. Global government bonds: Bloomberg Global Aggregate Treasuries (USD Hedged); Sterling corporate bonds: Bloomberg Sterling Corporate Bond Index (USD Hedged); Euro corporate bonds: Bloomberg Euro-Aggregate Corporate Index (USD Hedged); USD corporate bonds: Bloomberg Global Aggregate USD Corporate Index; High-yield bonds: Bloomberg Global High Yield Index (USD Hedged); Emerging market bonds: J.P. Morgan Emerging Markets Bond Index (EMBI) Global Diversified (USD Hedged).

Government bonds

Government bond yields broadly fell over the month. In the US, 2- and 10-year yields fell by 50 bps and 37 bps, respectively. In the euro area, German Bund 2-year yields fell by 30 bps, while 10-year yields fell by 20 bps. In the UK, 2- and 10-year gilt yields fell by 40 bps and 20 bps, respectively¹.

Corporate bonds

In credit, investment-grade spreads tightened over the month, driven by a supportive technical backdrop. Spreads in US-, euro- and sterling-denominated investment-grade corporates tightened by 1 bp, 10 bps and 9 bps, respectively².  However, emerging market (EM) spreads broadly widened over the month, with EM investment-grade and EM high-yield spreads widening by 8 bps and 13 bps, respectively³.

Monthly change in spreads (bps)

Source: Bloomberg indices: Global Aggregate Credit Average OAS Index, Global Aggregate Supranational Index, US Aggregate Corporate Average OAS Index, Euro Aggregate Corporate Average OAS Index, Sterling Aggregate Corporate Average OAS Index, US Aggregate ABS Average OAS Index, US Aggregate CMBS Average OAS Index, Global High Yield Average OAS Index, JP Morgan EMBI Global Diversified IG Sovereign Spread Index, JP Morgan EMBI Global Diversified HY Sovereign Spread Index. Data for the period 30 June 2024 to 31 July 2024.

The second-quarter earnings season was in full bloom in July, with over half of STOXX600 companies reporting their results. Overall, revenues were slightly below expectations, but earnings surprised to the upside, and ‘beats’⁴ still prevailed. We saw a number of significant earnings misses and guidance downgrades in consumer discretionary sectors such as Kering, the luxury goods manufacturer.  Meanwhile, defensive sectors such as utilities and healthcare, as well as financials and technology firms, broadly delivered better-than-expected results⁵.

The technical outlook remains positive in credit. This year saw one of the strongest new issuance starts to the year, with more moderate levels of expected supply in the coming months likely to support the positive technical backdrop through the end of 2024. As expected, election-related uncertainty in France and other European countries caused some temporary weakness in flows, but positive corporate fundamental drives have prevailed and spreads have now largely returned to pre-election levels.

Emerging markets

EM credit returned +1.9% in July. The uptick was entirely driven by the rally in US Treasuries, as EM spreads struggled to keep up, ending the month +9 bps wider. EM investment grade (+1.8%) performed in line with EM high yield (+1.9%).

We continue to believe EM high yield is vulnerable, as the widening in EM high-yield spreads is coming from very rich levels and EM high yield is more exposed than EM investment grade to the seasonal slowdown in liquidity that occurs during the summer months. Certain idiosyncratic stories saw fundamental improvements in July, including bonds issued by Ukraine (+10%), where the market began to expect more favourable restructuring terms.

Emerging market spreads had been tightening

Source: Bloomberg and Vanguard. Data are for the 24 months to 31 July 2024. Proxies used: EM investment-grade: Bloomberg EM USD Aggregate Average OAS Index; EM high-yield: Bloomberg Emerging Markets High Yield Average OAS Index. Calculations are in USD.

Outlook

We continue to believe fixed income as an asset class offers attractive levels of yield. Historically, yields at these levels have typically been followed by strong returns for investors over the subsequent six to 12 months.

In credit, spreads are consistent with a soft-landing narrative. Over the coming quarters, we expect to see a pick-up in corporate revenues and earnings growth. Away from earnings, we remain of the view that investment-grade company fundamentals are in good shape, thanks to the healthier balance sheets and de-leveraging efforts undertaken by many corporate issuers over the past few years. With the ECB and BoE delivering their first rate cuts after an intense monetary tightening cycle, and yields at attractive levels, we expect demand for credit to remain strong. Year-to-date issuance⁶ has now exceeded 70% of estimated full-year forecasts. We expect 2024 gross supply to be flat with 2023 levels. Within investment-grade credit, we are starting to see European investment-grade credit mean-revert and begin to outperform US investment-grade credit.

In high-yield credit, we are seeing a pick-up in rising-star activity this year compared with fallen angels⁷, as the macroeconomic environment has been more favourable than expected. Technicals in this sector are improving, driven by a lack of supply. A recessionary outcome would see lower-quality sectors more vulnerable, although yields at current levels are likely to offset some of the spread widening.

We are constructive on EM fixed income as fundamentals are strong and yields remain attractive, which we believe should support the asset class. However, valuations are tight and risks around US monetary policy remain.

¹ Source: Bloomberg and Vanguard, as at 31 July 2024.  

² Source: Bloomberg and Vanguard. Based on the Bloomberg Global Aggregate Credit Index, for the period 30 June 2024 to 31 July 2024. 

³ Source: Bloomberg and Vanguard. Based on the Bloomberg EM USD Aggregate Average OAS Index and Bloomberg Emerging Markets High Yield Average OAS Index, for the period 30 June 2024 to 31 July 2024.

⁴ ‘Beats’ refers to companies surpassing consensus analyst earnings estimates.

⁵ Source: Bloomberg and Vanguard, based on corporate earning results for the reporting period 1 April 2024 to 30 June 2024, as at 31 July 2024. 

⁶ YTD issuance represents the period 1 January 2024 to 31 July 2024. 

⁷ ‘Rising stars’ refer to high yield issuers whose credit ratings have been upgraded from sub-investment grade (Ba1/BB+ or lower) to investment-grade (Baa3/BBB- or above) by ratings agencies S&P, Moody’s and Fitch. ‘Fallen angels’ refer to investment-grade issuers whose ratings have been downgraded to below investment-grade. An increase in rising-star versus falling-angel activity can signal a strengthening economic environment and/or improved corporate fundamentals.