Fixed Income

Fixed Income Commentary – February 2023

Frosty Winter, Warm Markets

The first month of the year was favorable for bond investors as yields on Treasuries beyond two years declined. Enthusiasm over the diminishing pace of inflation played a big role in the recent rally. As a result, the total return for the broad market as represented by the Bloomberg U.S. Intermediate Aggregate Bond Index was 2.36%, while the Bloomberg Municipal Index returned an impressive 2.87%.

Despite the cumulative 450 basis points of rate hikes (as of February 1) and the start of quantitative tightening, the economy continues to display signs of resilience.  Most notable of these is the low unemployment rate of 3.4% (along with other metrics) which indicates tight conditions in the labor market.  Job vacancies as reported in the latest monthly JOLTS report* still show over 11 million openings and many industries continue to report shortages of skilled and unskilled labor.  This demonstrates a rippling effect that is still felt from the pandemic.  Some of these distortions now appear to be structural changes that will be longer term in nature.

Many will point out that labor markets are a lagging indicator for a recession. Other indicators that could augur for a recession are:

1) the five-month streak of job losses in the temp industry, which is often a precursor to cuts in the regular workforce;

2) declines in average weekly hours worked;

3) an increase in announced layoffs by large companies. 

In addition, the impact on economic activity from rate hikes takes months to be reflected in the data. It is important to note that monetary policy is a blunt tool as opposed to a precision instrument.  There is a myriad of ways in which higher rates affect lending activity, the labor market, and economic activity in general, so early-to-mid 2023 is when things may begin to slow more markedly as a result of the eight consecutive rate hikes.

The first read on fourth quarter GDP showed decent headline strength: real GDP grew at a 2.9% annual pace (although the details did reveal signs of slowing momentum).  Most troubling was the private final domestic demand component which came in at just 0.2%, providing some evidence that rate hikes and last year’s hit to wealth are reducing consumer demand.  Growth of inventories and government spending represented much of the strength, but a build-up of inventories into a slowing economy portends payback later as production plans may have to be scaled back.

Since Fed officials believe slack in the labor market is essential for wage costs to slow, the FOMC increased the fed funds rate again on February 1 to 4.5%-4.75%.  This time, the rate hike was just 25 bps (0.25%), reflecting the Fed’s desire to slow the pace of tightening and gauge the economy’s response to prior actions.  In the post-meeting press conference, Chair Powell expressed the view that more actions are likely, which could bring the fed funds rate to 5% or more. 

One of the ways for the Fed to achieve its objective of creating slack in the labor market is to keep the fed funds rate at a sufficiently restrictive level (say, at or above 5%) for a longer time period.  This would continue to curb economic activity, in part by reducing available income as loan rates are reset higher and debt service payment burdens rise.  Official comments in recent months have reiterated that the “terminal rate” will be in place longer during this cycle than in prior ones, although many market participants appear to doubt the Fed’s resolve in this matter.  Instead, many believe the pressure from any sharp weakening of the economy would bring an about-face in monetary policy which could result in a cut in the benchmark rate.  We are in the camp of taking the Fed’s word on “higher for longer” since the gap between current inflation and the 2% target remains too high. 

Risk spreads narrowed in January which enabled corporate bonds, mortgage-backed securities, and municipal bonds to outperform Treasuries.  Investor appetite for non-government bonds was strong and issuance of new bonds was on the light side, all of which helped propel the tightening of yield spreads.  Another factor behind this recent strength is the relatively favorable credit fundamentals for corporate and municipal bonds.

The other notable development in January was the return of the debt limit drama which forced the Treasury Department to enact “extraordinary measures” due to reaching the $31.4T debt ceiling.  Since markets have seen these partisan disputes before, the issue is likely to be a distraction and a modest risk until some resolution is reached later this year.  We do not expect a default or a ratings downgrade, and we do not believe risk spreads on corporate bonds will be impacted in any material way.

Looking ahead, central banks appear to be gaining some ground in the global fight against inflation but their resolve may be tested if clear signs of a recession emerge.  We believe more time and more action are needed to claim victory and we hope central bankers can maintain the discipline to get the job done.   Over the long term, a return to low inflation seems attainable given the slowing population growth in the world’s major economies, the steady increase in technological advances, and the enormous fiscal challenge if they fail.

* The job openings and labor turnover survey (JOLTS) is a monthly report by the Bureau of Labor Statistics showing job vacancies and separations, including the number of workers voluntarily quitting employment.

Important Disclosures

Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia.

This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication.  Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts.  No assumption or assurance should be taken that securities mentioned will be safe or profitable investments.  Past performance is not indicative of future results

For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected].  For further information about Maple Capital, including a copy of our informational brochure, please visit our website at

Index Definitions

The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US  dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

The Bloomberg Intermediate US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment  grade, US dollar-denominated, fixed-rate taxable bond market with less than 10 years to maturity. The securitized sector is wholly inluded. The index includes Treasuries, government-related and corporate securities, MBS, ABS and CMBS..

The Bloomberg US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.  Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index. STRIPS are excluded from the index because their inclusion would result in double-counting.

The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.

The Bloomberg US Mortgage Backed Securities (MBS) Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.

The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.

The Bloomberg U.S. Municipal Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.