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What's Driving Markets...

1. The Treasury Quarterly Refunding/Fitch Downgrade – The US Treasury held its quarterly refunding (gradually increasing the size of the Treasury's coupon auctions across the yield curve1) in July. We also include the Fitch Ratings downgrade of US credit from AAA to AA+ in this paragraph, somewhat ironically, because it explicitly did not meaningfully move the market. We found the event not surprising in one sense: The repeated debt limit stand-offs over the years aren't in line with the pristine quality of a AAA issuer. This contrasts with 2011, when the US was downgraded by S&P. Then, the downgrade had no impact on US borrowing abilities, but it did cause an immediate shock to equity markets. 



The Recent US Credit Rating Downgrade Had Little Impact on Markets, Unlike the 2011 Downgrade
10-Year US Treasuries vs. Cboe Volatility Index

Chart data as of 1/11-12/11. VIX, commonly referred to as the “Fear Index,” is the ticker symbol for the Chicago Board Options Exchange (Cboe) Volatility Index and measures the market’s expectation of 30-day volatility. VIX levels below 20 reflect complacency, while levels of 40 or higher reflect extremely high levels of volatility. Source: Bloomberg.


2. Economic data releases provided a little something for everyone. In the US, a gangbusters employment report, continued low jobless claims, and better-than-expected GDP numbers (2.4% vs. 1.8% expected) gave some fodder to Federal Reserve (Fed) hawks. However, these data points were balanced by a further moderation in inflation, as measured by the Consumer Price Index,2 which showed levels much more in line with Fed forecasts. Inflation appears to be slowing against a backdrop of still robust economic growth. Purchasing manager indices3 slowed across many regions, with manufacturing contracting in the eurozone, UK, and China, while services sectors generally remained in expansionary territory.

US inflation appears to be slowing against a backdrop of still robust economic growth.



Inflation Keeps Falling, But Remains Above the Fed’s Target
US Inflation (%, Year-Over-Year)

Current rates as of 6/23, forecasted rates as of 12/23. Sources: Bloomberg, Federal Reserve.


3. The Federal Reserve (Fed) hiked rates by 25 bps,5 as widely expected. Fed Chair Jerome Powell struck a relatively balanced tone at the press conference, leaving the option for additional hikes while reiterating that monetary policy is in restrictive territory. Going forward, the Fed will be monitoring when the “long and variable” lags from its tightening campaign to date impact the real economy. The resilience of US economic data suggests the lag may be longer than in the past. 

4. The Bank of Japan (BOJ)’s latest statement on monetary policy delivered a hawkish punch to rates markets near the end of the month, prompting the 10-year Japanese Government Bond (JGB) yield to move above 50 bps for the first time since 2015. The BOJ statement, whose implications were leaked to the press before the statement was released, pushed up US dollar (USD) rates on the back of robust US GDP data. Over time, domestic JGBs may prove to be somewhat more attractive for Japanese institutions vs. USD rates. While we’ve already seen a reduction of the Japanese footprint in 2022 due to interest-rate volatility in the US, as well as more expensive hedging costs, the future sunsetting of BOJ’s yield-curve control may lead to a less active Japanese buyer base.



US Treasuries Look Less Attractive to Japanese Investors As Foreign-Exchange Costs Rise

As of 7/31/23. Source: Bloomberg.


5. The Politburo in Beijing released a highly critical statement of the post-COVID-19 shutdown economic recovery in late July. The statement emphasized boosting domestic consumption, stabilizing the property sector, proactive fiscal policy, improved employment, and getting a handle on local government debt. The statement didn't mention specifics but was broadly welcomed by markets that await further details on fiscal easing in China. While the issues appear to have been identified, the markets still await specifics on funding details, size, and measures to promote consumption and stabilize confidence.

The global food supply seems far more fragile under the geopolitical dynamic.


What’s Keeping Us Up at Night…

1. Commodity volatility returned with the collapse of the Black Sea grain deal with Russia and the banning of non-basmati rice exports from India. The first is caused by ongoing tensions in the Russia-Ukraine war and means that a larger portion of the Ukrainian grain will have to leave overland, rather than by sea. The second issue is due to sharp increases in domestic prices of rice in India, forcing the government to curtail export of this critical staple. Both are reminders of the overall risk to markets and headline CPI that can arise from exogenous shocks to global food supply that seems fragile under the current geopolitical dynamic. Oil prices are also creeping upward, with both West Texas Intermediate (WTI) and Brent climbing above US $80 per barrel.



Rice Prices Are Skyrocketing in India
India Wholesale Price Index Rice Non-Basmati

As of 6/30/23. Source: Bloomberg.

2. Reaction function6 from China – Following the comments of Richard Koo, chief economist at Nomura Research Institute, who recently described the current situation facing China as a “balance-sheet recession,” we await what will be the reaction function of the Chinese central bank. Once diagnosed, balance-sheet recessions are generally fought with substantial fiscal spending. We haven’t seen any announcement of such a policy by Beijing, but if one were to come, it would have substantial impacts on global growth and inflation, as well as energy prices.


Investment Implications for Consideration

  • Given where spread7 levels are in many sectors, core bond/core bond plus8 positions may make sense as we approach (gradually) the end of the tightening cycle. Last year’s sell-off in dollar rates, rising geopolitical risk, and a gradually slowing economy make higher-quality fixed income attractive from a recessionary perspective, as well as for positive convexity.9 While inflation surprises still exist, a large portion of the move in rates has likely already occurred, potentially providing wiggle room and carry10 in case of upside inflation surprises. This view continues to grow in conviction, but we know that in the near-term returns may be primarily carry-driven until the economy slows further.
  • We continue to think that this is the environment for global sovereign and currency strategies to shine from a total-return perspective and a risk diversifier approach. This is another, more diversified, approach to monetize the ongoing and expected volatility of global capital markets. 
  • Securitized credit11 could be a potential hedge against rate volatility since they offer attractive risk-adjusted spreads. Senior parts of the capital structure, in particular, seem attractive in case the cycle turns faster than expected.
  • Shorter duration12 credit pays well given the ongoing volatility and uncertainty in markets. For low-risk appetite thresholds, the opportunity cost of this approach has diminished substantially over the last several months and the “higher-for-longer” approach could be indicative of robust carry.


Fixed-Income Sector Excess Returns

As of 7/31/23. Past performance does not guarantee future results. Excess returns are greater than the projected market rate of return. Indices are unmanaged and not available for direct investment. See below for representative index definitions. Sources: Bloomberg, JP Morgan, Wellington Management.


US Yields (%)

As of 7/31/23. Past performance does not guarantee future results. Source: Bloomberg


Fixed-Income Spreads (bps)

As of 7/31/23. US IG Corp is represented by the Bloomberg US Corporate Bond Index; US HY Corp is represented by the Bloomberg US Corporate High Yield Index, EMD is represented by the JP Morgan EMBI Plus Index, Bank Loans are represented by the LSTA Leveraged Loan Index; and MBS is represented by the Bloomberg US MBS Index. See below for representative index definitions. Source: Bloomberg, JP Morgan, Morningstar LSTA.

To learn more about opportunities in fixed income, please talk to your financial representative.


1  Yield curve is a line that plots interest rates of bonds having equal credit quality but differing maturity dates; its slope is used to forecast the state of the economy and interest-rate changes.
2  The CPI in the US is defined by the Bureau of Labor Statistics as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. 
3 Purchasing Managers' Index (PMI) is an indicator of the economic health of the manufacturing sector. A reading above 50 signals economic expansion; below 50 signals contraction.
4 PCE, or the Personal Consumption Expenditures Price Index (PCE) is defined by the US Bureau of Economic Analysis as a measure of the prices that people living in the US, or those buying on their behalf, pay for goods and services. The index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior. 
5 A basis point is a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indices and the yield of a fixed-income security. 
6 Reaction function is a contingency plan for how a central bank will react to certain events or data releases.
7 Spreads are the difference in yields between two fixed-income securities with the same maturity, but originating from different investment sectors.
8 Core/core plus typically invest in a baseline of investment-grade bonds such as government, corporate, and securitized debt. Core plus funds can take that baseline, and add additional sectors such as corporate high-yield, emerging-market debt, or non-US currency exposures to enhance returns. 
9 Convexity is the relationship between bond prices and bond yields.
10 Carry is the difference between the yield on a longer-maturity bond and the cost of borrowing.
11 Securitized credit involves pooling a large number of loans into an investable asset. Examples include mortgage-backed or asset-backed securities. 
12 Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement.

Global Aggregate is represented by the Bloomberg Global Aggregate Index, a broad-based measure of the global investment-grade fixed-rate debt markets. Euro Aggregate is represented by the Bloomberg Global Aggregate Index - European Euro, which includes fixed-rate, investment-grade Euro denominated bonds. UK Aggregate: Bloomberg Global Aggregate Index - United Kingdom which includes fixed-rate, investment-grade sterling-denominated bonds. US Aggregate: Bloomberg US Aggregate Bond Index is composed of securities from the Bloomberg Government/Credit Bond Index, Mortgage-Backed Securities Index, Asset-Backed Securities Index, and Commercial Mortgage-Backed Securities Index. US Fixed MBS: Bloomberg Agency Fixed-Rate MBS Index tracks fixed-rate agency mortgage backed passthrough securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). US CMBS: Bloomberg CMBS ERISA Eligible Index, which measures the performance of investment-grade commercial mortgage-backed securities, which are classes of securities that represent interests in pools of commercial mortgages. The index includes only CMBS that are Employee Retirement Income Security Act of 1974. US ABS: Bloomberg Asset-Backed Securities Index, the ABS component of the Bloomberg US Aggregate Index, which has three subsectors: credit and charge cards, autos, and utility. US IG Corporates: Bloomberg US Corporate  Bond Index covers all publicly issued, fixed rate, nonconvertible, investment-grade debt. US Corporates Aaa: Bloomberg Aaa Corporate Index designed to measure the performance of investment-grade corporate bonds that have a credit rating of Aaa; US Corporates Aa: Bloomberg Aa Corporate Index; US Corporates A: Bloomberg A Corporate Index, designed to measure the performance of investment-grade corporate bonds that have a credit rating of Aa; US Corporates Baa: Bloomberg Baa Corporate Index; designed to measure the performance of investment-grade corporate bonds that have a credit rating of Baa; US High-Yield Corporates: Bloomberg US Corporate High Yield Index is an unmanaged broad-based market-value-weighted index that tracks the total return performance of non-investment grade, fixed-rate, publicly placed, dollar denominated and nonconvertible debt registered with the Securities and Exchange Commission. Global IG Corporates: Bloomberg Global Credit - Corporate Index is an unmanaged index considered representative of fixed rate, non-investment grade debt of companies in the US, developed markets, and emerging markets. Emerging-Markets Debt: Bloomberg Emerging Markets Hard Currency Index includes USD-denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Bank Loans: LSTA Leveraged Loan Index, which is a market-value-weighted index that is designed to measure the performance of the US leveraged loan market based upon market weightings, spreads, and interest payments. JP Morgan Emerging Markets Bond Index Global Index is a broad-based, unmanaged index which tracks total return for external currency denominated debt (Brady bonds, loans, Eurobonds and US dollar-denominated local market instruments) in emerging markets. Bloomberg US MBS Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

“Bloomberg®” and any Bloomberg Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the indices (collectively, “Bloomberg”) and have been licensed for use for certain purposes by Hartford Funds.Bloomberg is not affiliated with Hartford Funds, and Bloomberg does not approve, endorse, review, or recommend any Hartford Funds product. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to Hartford Fund products.

Important Risks: Investing involves risk, including the possible loss of principal. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. • Mortgage-related and asset-backed securities’ risks include credit, interest-rate, prepayment, and extension risk. The value of the underlying real estate of real estate related securities may go down due to various factors, including but not limited to strength of the economy, amount of new construction, laws and regulations, costs of real estate, availability of mortgages, and changes in interest rates. • Loans can be difficult to value and less liquid than other types of debt instruments; they are also subject to nonpayment, collateral, bankruptcy, default, extension, prepayment and insolvency risks. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political, economic and regulatory developments. These risks may be greater, and include additional risks, for investments in emerging markets. • Diversification does not ensure a profit or protect against a loss in a declining market.

The views expressed herein are those of Wellington Management, are for informational purposes only, and are subject to change based on prevailing market, economic, and other conditions. The views expressed may not reflect the opinions of Hartford Funds or any other sub-adviser to our funds. They should not be construed as research or investment advice nor should they be considered an offer or solicitation to buy or sell any security. This information is current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management or Hartford Funds.

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Insight from sub-adviser Wellington Management
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Managing Director at Wellington Management LLP and Fixed-Income Strategist for Hartford Funds

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