Bonds may be sniffing out market weakness as traders rethink odds of 2024 rate cut

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A rally in junk bonds was on pause Friday after a robust jobs report

Rally in junk bonds hits pause on Friday after a robust jobs report has investors rethinking a cheery scenario of significant 2024 rate cuts.

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Bonds may be sniffing out market weakness ahead of stocks.

The sharp rally in U.S. high-yield or “junk” bonds since late October was on pause Friday, after the release of a robust jobs report for November called into question market expectations for significant rate cuts in 2024.

The junk-bond sector’s two biggest exchange-traded funds were trading lower on Friday and headed for weekly losses. The funds are a popular with individual investors and provide a way for institutional investors to manage liquidity needs when markets get choppy.

Shares of the roughly $18 billion Shares iBoxx $ High Yield Corporate Bond ETF
and the near $8 billion SPDR Bloomberg High Yield Bond ETF
were both down about 0.2% on Friday afternoon, according to FactSet data. Those levels also were near their weekly losses.

The junk-bond market tends to be a canary in the coal mine for financial markets, with the sector often quick to reflect a turn in sentiment.

“I think we have gotten far too over our skis,” John McClain, portfolio manager at Brandywine Global Investment Management, said in a phone call Friday. “You saw a rapid move in the 10-year yield from 4% to 5%, and from 5% back to about 4.1%.”

The 10-year Treasury yield
on Friday was back up about nine basis points to about 4.24%. In calm markets, the rate often moves daily only a few basis points in either direction.

The November retreat in benchmark borrowing costs has come on the heels of growing optimism about easing U.S. inflation that could prompt the Federal Reserve to cut rates sharply in the year head.

In a reversal, traders had the odds favoring a first Fed rate cut in May instead of March on Friday, according to the CME FedWatch tool.

McClain said he remains skeptical about the last leg of taming inflation, and sees a bumpy path to getting it down to the Fed’s 2% target.

Yet, recent optimism around rate cuts has bolstered the backdrop for risk assets, including fixed-rate junk bonds.

Investors poured another $1.5 billion into high-yield ETF funds in the week ending Dec. 6, a 72% weekly increase, which extended inflows to a sixth straight week, according to CreditSights.

More broadly, investors in the past week added exposure to corporate high-yield funds, while pulling assets from inflation-pegged TIPS funds, as well as other government and Treasury investments, according to BofA Global data.

Rates volatility in the U.S. bond market has been a wrecking ball in markets for two years. The hope has been that the worst of the damage from the Fed’s sharp pace of rate hikes since 2022 may be over.

Read: Investors are taking more risk as we near the end of 2023

In stocks, the Dow Jones Industrial Average
was up 116 points, or 0.3%, on Friday, continuing to narrow the gap on its record close two years ago. The S&P 500 index
was up 0.4% and the Nasdaq Composite Index
climbed 0.4%, according to FactSet.

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