State Street SPDR ETFs: The great credit re-pricing

State Street SPDR ETFs: The great credit re-pricing

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Bond markets remain volatile, with the start to Q4 seeing the US 10-year yield rise to a new cycle high of close to 4.25% before falling back to 4%. While the market now appears better supported, the path for rates will be determined by inflation, states State Street SPDR ETFs.

If inflation refuses to fall, optimism that the market has priced peak rates may give way to renewed selling of bonds – similar to what happened over the summer. For this reason, in the Q4 Bond Compass we suggested short-duration positions, limiting exposure to rising rates and high levels of volatility.

Reducing duration risk often implies forfeiting yield. However, this year’s aggressive re-pricing of the profile for central bank rate rises means this trade-off is less of a concern now that yield curves are quite flat. Indeed, the money markets imply Fed rates rising to May 2023 before easing back, while for the ECB and the BoE they are seen topping out over the summer of 2023.

Jason Simpson, Senior Fixed Income Strategist at State Street SPDR ETFs: 'For those investors looking to benefit from the higher yields on offer, post the summer correction in bond prices, yield can also be enhanced by focusing on investment grade (IG) credit strategies rather than straight government bonds.'

He continues: 'The flatness of the curve means that the yield to worst on the Bloomberg 0-5 Year Sterling Corporate Bond Index is 5.85%, just 3bp below that for the all-maturity Bloomberg Sterling Corporate bond Index. In other words, the trade-off between duration risk and yield looks far more favourable at the front end of the curve than for longer maturities.'

Figure 1 provides an illustration, where the horizontal axis shows the amount of yield per year of duration2 for various IG credit strategies. The four highest yielding ones relative to their duration risk are all short-maturity indices. Note also that the Bloomberg SASB Euro Corporate 0-3 year ESG Ex-Controversies Select Index offers a slightly better trade-off than the market-weighted Bloomberg Euro Corporate 0-3 Year Index.