Fixed Income Securities

Considerations for the High Yield Bond Market: The BB-rated High Yield (HY) bond market has shown strong performance, with favorable news recently related to growth and inflation.  Fundamentally, the companies represented in the HY Index have a favorable upgrade-to-downgrade ratio. BB-rated bonds constitute 50% of the HY market, distinguishing them from lower-rated B and CCC companies. BB HY bonds typically feature fixed rate, comparatively lower coupons, resulting in lower liability costs and more manageable debt service. In Contrast, the CCC-rated segment shows a concerning trend, with an upgrade-to-downgrade ratio below 0.5 (2x as many downgrades). The credit quality dispersion, shown in the chart below, reveals that BB vs. CCC-rated bonds trade at a spread margin of ~400 to ~1,200 bps, currently sitting inside of 750 bps.  While CCC credits can generate substantial returns during robust economic growth in a low default rate environment, and have rallied with the market in recent days, CCC deterioration is most pronounced during distress and recession. During the first half of 2020, the BB-CCC spread differential reached 1,200 bps, and in 2016, CCC spreads were even wider. It is noteworthy that Europe is straddling recession, and the BB-CCC European HY bond spreads have recently widened to 1,400 bps, surpassing its peak in 2020. So despite, the recent rally in lower-rated HY bonds, caution is warranted for the weakest segment of corporate credit. The HY bonds historical default rate: BB’s 0.4% default rate, B’s 1.4% default, and CCC’s a stunning 14.3% historical default rate! During a recession, default rates tend to increase significantly from historical measures. Composition of HY Index: 50% BB, 39% B, 11% CCC. 1 year ago, the HY Bond Index had 1.2% default rate. Today, the trailing 12M default for the HY bond market is 2.6%. By Q2 2024, I expect the default rate for high yield bonds exceed 4%. Michael Schlembach, Marathon Asset Management’s PM for High Yield, expects default rates to increase in 2024, with peak default rates potentially reaching ~1.0%, ~3.0%, and >20%+ for BB, B, and CCC’s, respectively. The key will be to invest in the debt of companies with solid fundamentals and financial strength to navigate the pending downturn. If you believe as I do that an economic slowdown (potential recession) is likely in 2024, it might be best to focus on higher quality credits with robust operating businesses within the HY market. Ford serves as a prime example in the BB sector, having recently been upgraded to Investment Grade by S&P, marking it as the largest 'rising star'. Ford represents 2% of the HY index with $41 billion of bonds, its upgrade has spurred demand for other quality BB-rated bonds to replace it. While recent inflows have tightened BB spreads, I advise against trading based solely on the technicals, as this post is intended purely for informational purposes. U.S. HY rated BB vs. CCC Differential:

Government bonds underperformed equities, credit and commodities in this 3-year risk on market. Our analysis shows when equities sell off, Treasuries are also less diversifying compared to decades prior (chart). What’s happening? Long bond yields are made up of 2 components: ➡️ Policy path - in a world shaped by supply, central banks are more limited in their ability to come to the rescue of the economy without reigniting inflationary pressure. Hence Treasuries are less reliable when equities fall. ➡️ Term premium - it’s driven by bond volatility, inflation uncertainty, and of course fiscal dynamics. Think of it like any other type of risk premium such as equity risk premium it’s about perceived risk and additional required compensation above risk-free for holding it in portfolios. Large deficits record debt and heavy issuance mean that term premia can reprice higher, maybe especially during stress, pushing long yields up even as markets may price a lower policy path. Together, these forces weaken the traditional stock–bond hedge. I think of Treasuries now as quality income assets not the diversifiers they used to be.

YIELD CURVE MODELING: MASTERING THE COMPLETE TERM STRUCTURE WITH NELSON-SIEGEL-SVENSSON 📈 In fixed income markets, understanding yield curves offers profound insights into economic expectations, interest rate risk, and relative value. Beyond basic curve analysis, parametric modeling techniques allow us to mathematically capture the entire term structure with remarkable precision. The Nelson-Siegel model provides an elegant three-factor representation of yield curves: r(t) = β₀ + β₁[(1-e^(-λt))/(λt)] + β₂[(1-e^(-λt))/(λt) - e^(-λt)] Each component has an intuitive economic interpretation: β₀ represents the long-term interest rate level (horizontal asymptote) β₁ controls the curve's slope (short-term component) β₂ determines the curve's curvature (medium-term component) λ dictates the decay rate and positioning of the hump For even greater precision with complex yield curve shapes, Svensson's (1994) extension introduces a second curvature term with a separate decay parameter μ: r(t) = β₀ + β₁[(1-e^(-λt))/(λt)] + β₂[(1-e^(-λt))/(λt) - e^(-λt)] + β₃[(1-e^(-μt))/(μt) - e^(-μt)] This parameterization allows for capturing multiple humps and troughs in the term structure with minimal additional complexity, making it particularly valuable for central bank modeling and fixed income portfolio management. The yield curve's shape itself conveys powerful economic signals: - Normal upward-sloping curves typically indicate healthy economic growth - Inverted curves often presage economic contractions - Flat curves suggest economic transitions - Humped curves point to mixed economic signals For investment professionals, mastering these term structure models provides a substantial edge in risk management, relative value analysis, and economic forecasting. Which yield curve modeling techniques have you found most effective in your practice, and how do you incorporate them into your investment decisions? #FixedIncome #YieldCurve #TermStructure #QuantitativeFinance #RiskManagement #InterestRates

There's something counterintuitive about the impact of rising rates on bonds. The math behind the forecastability of bond returns is fascinating (…at least to a geek like me). Higher reinvestment rates offset interest rate shocks over time. If rates unexpectedly spike, the portfolio should go down immediately. However, we now expect to earn more yield than we did before the rate shock. If we ignore several less-important subtleties such as yield curve effects and the timing of the rate shock, this offset effect works no matter the size of the rate shock. It explains why historically, the initial yield-to-maturity has been a remarkably good predictor of forward return for bonds. The “sweet spot” of forecastability, or close enough to it, is when the investment horizon matches the portfolio's duration. Bond investors tend to worry about rising rates because of the short-term losses that occur when rate hikes aren’t already priced into the forward curve. However, contrary to conventional wisdom, this example illustrates how rising rates are good for bonds: higher rates mean higher reinvestment rates, and ultimately, higher expected returns. Adapted from Beyond Diversification, McGraw-Hill.

Treasury yields are never just one number—they’re three stories at once. Using August 2025 as example, the 10-year Treasury at 4.23% breaks down into: A • 2.38% expected inflation • 0.97% expected real short rate (R*) • 0.88% bond risk premium That’s the real anatomy. Two-thirds of the yield is about inflation credibility. The rest is growth equilibrium and investor sentiment toward long bonds. History matters. From the 1980s to 2020, all three components fell—driving the great bond bull market. Post-2021, it flipped. Inflation expectations stayed anchored, but real rates and premia moved back into positive territory. That’s why bonds finally pay a real yield again, but their diversification role is weaker. Here’s the friction. Investors who still think of Treasuries as “return-free risk” are behind the curve. With ex-ante real yields near 2% and premia close to 1%, bonds contribute to returns again. But if inflation expectations de-anchor, the hit is double—yields climb, correlations flip positive, and the hedge role disappears. Global data shows the same pattern: higher real yields and premia driving the shift everywhere from Germany to Canada, with Japan as a partial outlier. Diversification isn’t dead—it’s just not as simple as “own bonds and you’re safe.” Portfolio takeaway: • Treasuries are investable again—don’t ignore them. • But they’re not a perfect hedge—pair them with other diversifiers like gold, trend, or alts. • Think global, not just U.S.—the repricing is worldwide. Would you treat bonds as a return engine or a hedge in this cycle? If inflation expectations break higher, how does your allocation shift? Do you diversify bond exposure globally—or concentrate in the U.S.? What’s your alternative hedge if Treasuries fail? For more see our Nomura CIO Corner: https://lnkd.in/e4TCax_g #Treasuries #BondMarkets #Yields #Inflation #Diversification #Nomura #CIO #Macro #Markets

 🚩A Crucial Market Is Sending Its First Warning Signal The Fed’s rate-hiking campaign could still weigh heavily on the economy, not least by making it harder for companies to access funding. But on the surface, investors seem confident that most US companies will generally be able to handle a slowdown without shutting down. That’s clear in the fact that the high-yield spread — that’s the extra yield that investors demand for buying riskier corporate bonds over safer government bonds — is still quite narrow. This indicates that investors aren’t too concerned about a spike in company failures, which would wipe out the interest from the riskier bond’s payments. But as always, the devil is in the details. Look deeper within the high-yield sector, and you’ll see investors are now asking for much higher rewards for holding the riskiest “junk bonds” – specifically those rated CCC (light blue line in the chart) – compared to the slightly less risky B-rated junk bonds (dark blue). Of course, it’s hardly surprising that CCC bonds boast higher yields than single B’s. They’re marginally riskier, after all. But historically, that difference has been slight. And over the past few months, the gap has been widening significantly. That suggests that investors are increasingly wary of defaults within the most speculative pockets. Now, that could be due to sector-specific concerns – CCC bonds are more common in media, consumer products, and high technology – or concerns that a tougher economic environment could wipe out companies with a weak spot financially. That's a worrying trend. As you can see in the chart, the last time we saw such a gap was right before the dot-com bubble burst. Investors poured money into highly speculative ventures during the tech boom, many of which carried CCC ratings. And as the sustainability of those businesses came into question, investors demanded much higher returns to offset the heightened risks. That led to a sharp spike in the yield spreads of CCC-rated bonds over B-rated bonds, a clear signal that investors saw potential for severe financial distress in those companies. That warning sign started flashing about a year before the bubble burst. A similar pattern unfolding today suggests that not everything is stable beneath the surface. The rise in CCC-rated yields indicates that the chance of defaults for the most speculative companies are rising, and is higher than the high-yield spread suggests. The risk from here is that the economy slows down more aggressively or borrowing costs stay high for longer than hoped, then these fears of defaults could spread to other companies – as it did before the dot-com bubble popped. More worryingly, that could bring trouble for private credit lenders, which loan to similarly smaller, debt-laden private companies. And since private markets may represent an important threat to our financial system, this is a risk worth watching. > Finimize

Global term premia are rising. And Japan's curve is showing it most clearly. After a decade of compressed curves and suppressed term premia, the tide is turning. We’re seeing a regime shift in global bond markets. Term premia, the risk premia and compensation for holding long duration bonds, are rising again. Ironically, and for much of the 2010s, Japanese (and German) yields were the global low yield anchors with negative term premia. Now Japan leads the pack. Why? Three drivers: 1) BoJ balance sheet reduction (quantitative tightening), 2) fiscal concerns, 3) political uncertainty. But there is a neglected point in all of this: Ahead of Japan’s new solvency rules (April 2025), Japanese insurers bought ultra-long JGBs to match liabilities under a market-consistent framework. Now that shift is largely complete. Insurers are no longer adding JGBs at the same pace as a result of the rule change. And with that, a major anchor of the long end is gone, at least for now. So, term premia are back. And they are emblematic of a new macro-financial regime where supply, duration risk, and policy volatility matter again.

For most of the last few decades, Japan’s economy has maintained interest rates close to zero to combat deflationary pressures. Today’s rate hike by the Bank of Japan (BoJ) marks a slow but deliberate move away from that long-standing framework. Policy rates have risen to 0.75%, the highest level in roughly three decades, reflecting persistent inflation and signs of stabilizing wage growth. Crucially, this shift has pushed Japanese government bond yields sharply higher. The benchmark 10-year JGB yield has climbed past 2%, levels not seen since the mid-2000s, as markets price in the BoJ’s gradual normalization path. The global significance of this move lies in Japan’s long-standing role as a source of low-cost yen funding. For years, investors have borrowed in yen to seek higher returns abroad. As interest rates rise, the yen carry trade becomes less attractive, increasing the likelihood that some of this liquidity could return to Japan. This adjustment may influence global asset prices and borrowing costs, particularly if investors reduce exposure to riskier assets. The decision also intersects with Japan’s fiscal reality. With one of the highest public debt levels globally, Japan has benefited from ultra-low interest rates that kept debt-servicing costs manageable. As rates rise, even gradually, the cost of funding government deficits will increase, underscoring the need for careful coordination between monetary and fiscal policy. What’s the takeaway? Japan’s rate hike signals a structural shift away from decades of ultra-easy monetary policy, with implications extending well beyond its borders. Looking ahead, the BoJ is expected to proceed cautiously given Japan’s fragile growth outlook. Equity markets may experience near-term volatility as investors reprice risk and unwind yen carry trades, potentially pressuring global equities. If inflation and wage growth continue to evolve as anticipated, further steps toward policy normalization remain possible. #Centricity

Bonds are attractive now In an environment where rates stay high for longer bonds are giving investors inflation-adjusted real yields, the opportunity for capital gains when rates go lower, and a flat yield curve meaning that shorter or longer maturities pay the same rates giving us the choice in terms of risk and liquidity Higher rates for longer also most likely are a detriment to the equity markets as they impede corporate profitability with many potential projects being taken off the table due to higher funding costs and breakevens Go for higher quality bonds the spread in high yield and Emerging Markets is insufficient currently to reward investors for the additional risk ...and higher quality government bonds are tax-free or tax efficient in many countries Stay liquid... currently the illiquidity premium is insufficient to warrant giving up liquidity for small increases in yield If you believe rates are coming down soon then extend your maturity to 5 or 10 years as you will reap significant capital gains in your portfolio as rates come down. If you think rates are going higher in the near future then stay in the short end and your yield will move up with rates with little or no effect on the capital price of your bonds The author is a fixed income expert and CIO of LNG Capital a London based hedge fund specilising in fixed income. Louis speaks regularly and is involved frequently in public dialogue about investments asset class allocation and portfolio construction. He is a Non-Exec on several boards helping companies with strategy and growth. #bonds #equity #markets #investing #stocks #rates #inflation #portfolio Fixed income should have more love in a ‘higher and hold’ world - https://on.ft.com/3V45Raf via @FT

The Term Premium: A Subtle Force Behind Balance Sheet Risk The term premium is one of the most overlooked forces in balance sheet management. It affects the shape of the yield curve, the pricing of fixed income products, and the valuation of long-term assets and liabilities. And yet, it often receives little attention in day-to-day treasury or ALM discussions. Understanding the term premium—and how it moves—is beneficial for making realistic decisions about hedging, lending, and investment strategies. When misunderstood, it can distort the bank’s duration positioning, mislead IRRBB assessments, and affect commercial pricing. Here are three reasons why the term premium matters more than many assume: 1. The yield curve is not just about rate expectations Many interpret the yield curve purely as a signal of future interest rates. But in reality, it reflects two components: expected future short-term rates and a term premium. The term premium compensates investors for the risk of holding long-term securities in an uncertain environment. If the term premium is negative—common in recent years—long-term rates may be lower than short-term expectations suggest. Relying solely on forward curves without considering the term premium can lead to flawed duration and hedging decisions. 2. Term premium affects the valuation of structural hedges Structural hedging often involves placing long-term fixed-rate swaps or purchasing long-duration bonds. If the term premium is compressed or negative, those instruments may be priced tightly, offering little compensation for long-term risk. This makes structural hedging more expensive and increases mark-to-market sensitivity. A realistic understanding of the term premium helps treasury teams calibrate hedge sizing, tenor, and timing more effectively. 3. A changing term premium shifts IRRBB and FTP dynamics When the term premium rises—due to inflation fears, fiscal uncertainty, or reduced central bank intervention—long-term funding becomes more expensive, even if policy rates are stable. This shifts the FTP curve, affecting product pricing and business line behaviour. A rising term premium can also steepen the EVE sensitivity profile, exposing the bank to value erosion unless hedges are adjusted. Without active monitoring, these shifts can quietly embed risk into the balance sheet. So how should banks account for the term premium? It starts with awareness. Treasury and ALM teams should monitor market signals—swap spreads, long-term bond yields, and central bank activity—to estimate the implied term premium. While it is not directly observable, various market-based estimates can provide useful reference points. From there, it should be incorporated into hedging strategy, FTP calibration, and scenario analysis. This allows for more grounded expectations of long-term rate moves, helping to avoid over-hedging or mistimed duration positioning.