Fixed Income

Fixed Income Commentary – September 2022

The Hole Story


Bond yields rose substantially in August as investors interpreted numerous comments from Fed officials as bearish.  All tenors in the one to ten year part of the yield curve rose by 50 basis points or more.  As a result, the total return for the Bloomberg U.S. Intermediate Aggregate Bond Index was -2.49% for the month.

Chair Powell’s brief statement at the annual Jackson Hole monetary policy symposium was as clear as Jenny Lake: the Fed will raise rates further and hold them there longer until inflation is substantially back near its 2% target.  Numerous FOMC members have opined that even after the Fed stops raising rates, it’s likely they will have to remain in restrictive territory for some time in order to bring inflation back down.  Perhaps this is a recognition that the war and certain other supply-side constraints may prove more formidable than previously thought, and monetary policy alone may not be effective in taming those elements quickly.

In terms of economic data, there continue to be many signs that economic activity remains resilient, which is why the Fed is tightening policy — they need to restrain the inflation impulse.

• The ISM Manufacturing and Non-Manufacturing surveys remain above 50, which indicates expansion;

• Non-farm payrolls expanded by over 500k in July and prior months were revised higher, while the number of job openings also came in higher than expected;

• Consumer confidence measures are on the rise, in part due to lower gas prices;

• Ex-auto/gas retail sales for July rose more than expected.

At the same time, some economic indicators already show the effects of higher interest rates, particularly new home sales.  This slowdown in housing activity is also due to the higher prevailing prices which have forced many would-be buyers out of the market, and this is exactly what the Fed wants to see: lower sales activity which will presumably help slow the pace of price gains, if not to outright price declines in some markets.  Rent increases have also been stubbornly high and need to come down for the housing inflation component to begin contracting.

Getting inflation back down to the Fed’s target of a 2% average will take time but some areas are starting to help: commodity prices have fallen substantially since June and the strong dollar is keeping imported goods prices at bay.  Also, used car prices have begun to turn lower, likely a function of improved supply chain dynamics but also a reaction to higher prices reducing demand (the cure for higher prices is higher prices!). 

We expect these trends will accelerate and will eventually allow the inflation battle to be won.  That said, it will not happen overnight nor will it be a straight line.  The Fed knows this and they will continue to use their bully pulpit to talk tough, another necessary element to bringing inflation expectations down for consumers and businesses.

In terms of sector developments, yield spreads for corporate and municipal bonds were mostly flat in August, a  pretty respectable feat in the face of lower equity markets, higher volatility, and negative sentiment.  We have remained cautious in deploying cash given this backdrop and the too-rosy outlook that was reflected in prevailing Treasury yields, but value can be found in the market in select issues and spots on the yield curve.  The residential MBS sector has also been under some pressure in recent weeks, partly due to the Fed’s quantitative tightening policy which is about to reach its maximum pace in September.  This means the Fed’s MBS holdings are slowly shrinking and a major buyer is no longer engaged, so valuations have been adjusting to this shift. 

The fact that higher interest rates are contributing to lower equity prices and slowing economic activity is a reminder of just how important the bond market is for overall economic vitality.  It’s also fascinating to see so much attention being paid to the Fed’s actions when many have claimed that monetary policy is ineffective or irrelevant.  The reality is that the bond market remains an enigma to most Americans, and we hope that these monthly commentaries add to your understanding of the myriad factors that impact bond yields and prevailing interest rates.


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 www.maplecapital.com.

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.