• May was a generally positive month for fixed income markets, amid speculation around the timing and magnitude of interest rate cuts by central banks.
  
  
• In developed market government bonds, performance varied across regions, with US 2- and 10-year Treasuries rallying over the month.
  
  
• In credit markets, investment-grade spreads broadly tightened, driven by positive corporate growth sentiment.
   

Fixed income markets broadly rallied in May, amid speculation around the timing and magnitude of interest rate cuts by major central banks.

In the US, market and inflation data showed signs of softening, though still remained above trend, with headline and core inflation (which excludes food and energy prices) falling to 3.4% and 3.6%, respectively. In the UK, headline and core inflation also declined, to 2.3% and 3.9%, respectively; while in the euro area, headline and core inflation rose slightly, to 2.6% and 2.9%, respectively, driven by wage increases. The uptick in euro area indicators raised some concerns that the European Central Bank (ECB) might rescind on indications around cutting rates at its June meeting, yet as of the time of writing, the bank subsequently announced a 25 basis point (bps) reduction in its key deposit facility rate, from 4.0% to 3.75%)¹.

Meanwhile, at their May meetings, both the US Federal Reserve (Fed) and the Bank of England left interest rates unchanged at 5.5% and 5.25%, respectively, citing inflationary concerns, but both sets of policymakers affirmed that they remained confident that inflation could still reach target levels.

Monthly returns 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 April 2024 to 31 May 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

Developed market government bonds posted mixed results in May. In the US, 2- and 10-year Treasuries rallied, with yields falling by 16 and 18 bps, respectively. In the UK, 2- and 10-year gilt yields also fell, by 10 and 3 bps, respectively.  In the euro area, German 2-year government bond yields rose 6 bps, while 10-year yields rose by 8 bps². 

Corporate bonds

In credit markets, investment-grade (IG) spreads broadly tightened over the month, driven by positive corporate growth sentiment.  US, euro and sterling IG spreads tightened by 2, 4 and 7 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, J.P. Morgan EMBI Global Diversified IG Sovereign Spread Index, J.P. Morgan EMBI Global Diversified HY Sovereign Spread Index. Data for the period 30 April to 31 May 2024.

2024 has been one of the strongest starts to the year for credit markets, as investors looked to lock in the sector’s attractive yields ahead of potential rate cuts⁴. The robust demand helped absorb outsized levels of new issuance earlier in the year, although we expect the pipeline of new supply to fall back towards more normal levels for the rest of the year. With attractive yields and further rate cuts on the horizon, the demand for credit is expected to stay strong – which, combined with more constrained levels of supply, could put further downward pressure on spreads later in the year.

Results from the latest earnings season painted an optimistic picture for the second half of 2024. While earnings for European corporate issuers declined compared with last year, most IG companies surprised to the upside and trends suggest that earnings are bottoming out. Companies across sectors reinforced positive outlooks for the rest of the year. We expect a strong rebound in sectors such as real estate, basic materials and technology.

Emerging markets

Emerging market (EM) credit returned +1.8% in May, benefitting from the rally in 10-year US Treasuries as US growth cooled. EM IG (+2.1%) outperformed EM high-yield (+1.5%). Impressive rallies in EM sovereign bond issuers like Argentina and Ecuador left EM high-yield (HY) valuations stretched. Overall, both EM IG and EM HY spreads tightened over the month, by 4 and 1 bps, respectively⁵.

EM investment-grade and high-yield spreads compressed further in May

Source: Bloomberg and Vanguard. Data are for the 24 months to 31 May 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

Looking ahead, markets remain focused on economic data and the potential for future rate cuts. Until now, the soft-landing narrative has continued as US growth remains resilient, yet soft growth in Europe and the recent policy cut by the ECB highlight a divergence between regions – suggesting a complex and uneven recovery path may lie ahead.

In credit markets, European IG issuers are beginning to mean-revert and outperform their US IG counterparts. We continue to see more value in European IG and hold an overweight position to European IG versus US IG, where spreads remain compressed. Our focus remains on well-capitalised companies with strong balance sheets. In HY corporates, there’s been a pickup in rising-star activity compared with fallen angels⁶, as the better-than-expected macroeconomic environment proves favourable for issuers.

In EM debt markets, we are constructive as fundamentals are strong and yields are attractive, which should support the asset class, in our view. However, valuations are tight and risks around US monetary policy remain.

Historically, yields at these levels have typically been followed by strong returns over the following 6-12 months.
 

¹ The move marked the first rate cut by the ECB since 2019. Source: Vanguard.

² Source: Bloomberg and Vanguard.

³ Source: Bloomberg Global Aggregate Credit Index, 30 April to 31 May 2024.

⁴ Source: Vanguard.

⁵ Source: J.P. Morgan EMBI Global Diversified IG Sovereign Spread Index, J.P. Morgan EMBI Global Diversified HY Sovereign Spread Index. Calculations for the period 30 April to 31 May 2024.

⁶ ‘Rising stars’ refer to HY 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. An increase in rising-star versus falling angel activity can signal a strengthening economic environment and/or improved corporate fundamentals.