The fourth quarter of 2023 was one of the strongest for financial markets in the last two decades, with the Bloomberg global bond aggregate returning +5.0% in November (the strongest return since December 2008) and +4.7% in December. At the same time, the S&P 500 posted returns of 9.1% and 4.5% in November and December, respectively.
Declining inflation prints through the quarter, in the face of growth data that remained above expectation, helped build the narrative that developed market central banks might actually do the impossible and engineer a soft landing, further reinforced by December’s Federal Open Market Committee meeting that saw Federal Reserve Chair Jay Powell surprise markets with a dovish pivot. The market was pricing in approximately 70bps of cuts from the Fed in 2024 at the end of October but by the end of December this had moved to approximately 160bps of cuts (and a 100% probability of a cut by March), with similar moves in market expectations for both the European Central Bank and the Bank of England.
After such a strong end to 2023, we have not been surprised to see the market soften slightly as we start the new year. Ten-year US treasuries were approximately 10bps wider over the first two trading days, most likely driven by the move in the short end. This has helped reduce the probability of a cut by March from 100% to 80%, before a small rally into the Fed minutes last night (we thought this was generally more hawkish than Powell’s December meeting but included some interesting comments around the potential slow-down of QT), while the 90bps move in 10-year gilts in November and December has given approximately 12bps back over the last two days.
At last night’s close, Credit had followed the rates move, with Xover (the proxy for European high yield spreads) +30bps year to date, and CDX (the proxy for US HY spreads) +20bps year to date. It is worth pointing out, however, that Euro and US HY gave investors returns of +12.0% and +13.5% respectively in 2023.
While we expect volatility to remain elevated, we believe the pull back so far this month is a healthy reaction to the very strong performance at the end of last year. Of particular interest this month will be how the market takes down any supply, with some of the early deals so far multiple times subscribed, particularly for the higher quality names (Ford, for example, issued a dual tranche dollar deal yesterday, with books approximately three times over-subscribed).
We think selectively taking advantage of supply this year will drive strong returns in future years with all-in yields significantly above longer-term averages in many credit sectors offering investors attractive coupons. We would also wager that a more material sell off (with no significant changes in the macro picture) might be met with a bid from those who did not participate in the rally in November and December, thereby limiting how far yields and spreads can bounce higher.
Ultimately, with developed market central banks poised to pull the cutting trigger, the market will continue to remain laser focused on any data that will guide towards that first cut. Friday’s nonfarm data will be the first major data release of the year, and we will be watching intently to see how a particularly strong labour market in the US ended 2023.