Fixed Income Securities

Bond prices move opposite to yields But why does this inverse relationship exist? The answer lies in simple demand and supply. Let's see... Assume the Government of India issues a bond which pays 8% interest, and has a tenure of 1 year. If the face value of this bond is Rs 100, it will pay the bond holder 108 at the end of the first year. The final payout is fixed (and hence the name fixed income). If we pay Rs 100 for this bond, we will make an 8% return If we pay > 100, the return will be lower If we pay < 100, the return will be higher Now if interest rates in the economy have changed, the Government will have to issue new bonds at a different rate. Say it issues another 1-year bond with 10% interest, this bond will pay Rs 110 at the end of the first year. Everyone would want to buy this bond, instead of the earlier one. All things being same, anyone holding the earlier bond will try to sell that, and buy the new one. The earlier bond will see a huge supply, which should result in prices going down. Prices will go down to the point where the return on the old bond matches the return on the new bond (10%). Thus, as the interest rates increase, the demand for the new bonds is higher, and the price of existing bonds drops. If the new government bond offered lower interest, demand for existing bonds would have increased, increasing their price. And that explains the inverse relationship between bonds yields and bond prices. Why is it important? As a #fixedincome #investor, if yields are going up, then existing bond prices will fall with rising yields. And fixed income, which appears to be a safe investment, can become risky in a rising yield environment. ---- I try to teach practical #finance concepts through my writing. Follow me (Peeyush) if you are building a career in finance and do check out my earlier posts.

What's the bond market signalling here? Bond markets are often referred to as ''smarter'' than equity markets in predicting what's next for the economy. Yet the reality is a bit more nuanced. Today, bond markets are pricing the Fed to proceed with ~175 bps of cuts in the next 12 months hence bringing Fed Funds from 5.25% to 3.50%. How does one interpret this? The typical superficial analysis involves looking at these cuts in a simplistic fashion: 175 bps in a year is a robust cutting cycle, so that must mean inflation has collapsed or even a mild recession has hit the US economy. But what if we think in scenarios? 1) Recession 2) Soft Landing 3) Sticky inflation / Structural ''Higher for Longer'' A more useful way to think about the ~175 bps number is to think of it as the weighted average of scenarios probabilities and Fed actions in each scenario. 1) Recession: 350-400 bps of cuts 2) Soft Landing: 100-200 bps of cuts 3) Sticky inflation / Structural H4L: 0-50 bps of cuts This is a simple split - you can add more layers too (e.g. deep or shallow recession, etc). The point is that through the option market you can pinpoint what are the market-implied probabilities for each scenario. Today, the bond market thinks the following: - Recession: 20% * 400 bps cuts - Soft Landing: 50% * 150 bps cuts - Sticky inflation / Structural H4L: 30% * 25 bps cuts The weighted average of these probabilities and Fed cuts in each scenario is reflected in that single ~175 bps of cuts you see on the screens. But a lot more information can be extrapolated by looking at single probabilities and scenarios. If you are interested in getting regular and granular updates about these probabilistic scenarios and pricing, ping me (Alfonso Peccatiello) on Bloomberg to try out my macro research.

Bond markets in no mood for U.S. rating downgrade   Equity markets rallied last week, boosted by encouraging news on the U.S./China trade front and cooler inflation data, but encountered headwinds to kick off this week. Ratings agency Moody’s, citing rising U.S. budget deficits and net interest costs, lowered U.S. government debt from its highest rating to Aa1. (Fitch and S&P have already knocked down U.S. debt a notch.) Bond prices fell in early day trading, with the yield on 30-year U.S. Treasuries breaching the 5% mark. Heading into the Memorial Day weekend, U.S. stocks may struggle to find fresh catalysts to extend their gains given the limited calendar of economic data releases. But on Friday, new home sales for April could provide insight into the health of the housing market. Outside the U.S., though, business surveys from France, Germany and the U.K. — Europe’s three-largest economies — could provide insight into the effects of U.S. trade policy on the global economy. For investors looking to reduce their exposure to trade policy uncertainty and sidestep the Moody’s downgrade, we recommend municipal bonds, thanks to their attractive yields, tax benefits and stable credit quality.    While munis are impacted to some degree by the performance of U.S. government debt, state and local governments are on sound financial footing thanks to healthy levels of “rainy day” funds. And importantly, we don’t expect Moody’s action to have an outsized impact on the muni market. For more detailed analysis and insights on the merits of investment grade and high yield municipal bonds, check out our latest CIO Weekly Commentary, “Munis make their mark amid tariff uncertainty”: https://lnkd.in/gJKURdAk In the current environment, would you consider adding municipal bonds to your portfolio?

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

🔴 After yelling at Yellen, Bessent is now following the Yellen path. Bessent wants to fill the Treasury General Account (TGA)—the government's bank account—to $500- $800 billion before the end of July. To refill the TGA, the Treasury Department will issue very short-term bonds: 4-week and 8-week maturities. But why is the Treasury now refilling the TGA with short-term bonds when it harshly criticized former Treasury Secretary Janet Yellen for front-loading trillions of dollars in debt? It’s not because Yellen was right or Bessent was wrong, but because the foundation of the market structure has changed. There are basically 2 types of securities in the Debt Market: Short-term bonds, which mature in less than a year, and long-term bonds, which mature in more than a year—up to 30 years. Short-term bonds (which make up the front end of the yield curve) are often referred to as “on-the-run” securities. They are more liquid, more in demand, and widely used as collateral by financial institutions for interbank lending. In contrast, long-dated bonds—called “off-the-run” securities—are less liquid, less desirable, and not often used for collateral in intra-financial transactions. They tend to sit on balance sheets, and the market demands a discount on them due to their illiquidity. The key point is: the market holds a wide range of bonds across the yield curve. But after the massive COVID-era money printing, when bondholders lost up to 30% of their value, investors have become more cautious—especially with long-term bonds, because they’re less liquid. In simple terms, after COVID, the market lost its appetite for long, off-the-run bonds. It now prefers short, liquid, on-the-run bonds. The shorter the maturity, the stronger the demand. The market today is addicted to liquidity, much like a drunk man to alcohol. As the Treasury needs trillions to plug the deficit, and the market prefers short-term bonds, it’s now issuing ultra-short 4- and 8-week securities. The Treasury is no longer doing what it should—it’s doing what it can. Short-term, on-the-run bonds increase liquidity and help keep long-term yields low. If the government issued long bonds instead, yields would rise sharply. So in effect, this is a form of yield curve control. In the end, all roads lead back to QE /YCC—both of which mean printing money and increasing liquidity. But neither has truly worked, and Japan is the clearest example of that. Now, more and more debt is moving to the short end of the yield curve. And as demand for U.S. bonds declines—especially from foreign buyers—the burden will shift increasingly to domestic holders. U.S. banks, financial firms, and savings institutions will be forced to buy more. When they reach their limits, the Fed will step in and buy the bonds—just as the Bank of Japan is doing today. It’s all financial engineering, but it doesn’t truly help a nation. America needs Real Engineering.

Bond yields moved higher in the first two months of the year as the market repriced #Fed expectations. But what’s the outlook for interest rates and fixed income investments as we kick off March?   While we anticipate another healthy employment number this Friday, we still expect 75bps of cuts in 2024, starting midyear. Our near-term range on the 10-year US Treasury #yield is 4% to 4.5%, before moving toward 3.5% by year-end.   While a temporary move toward the top of that range is possible, we believe this would likely require a shock in the form of materially higher #growth or inflation, and we would be strong buyers around the 4.5% level.   In terms of positioning, CMBS continues to outperform, particularly the lower-rated BBB segment. We remain most preferred in the higher-quality CMBS sector. While spreads tightened over the past six weeks, CMBS remains cheap relative to their corporate credit counterpart.   With inflation expectations rising, TIPS have outperformed their Treasury counterparts, and we remain with a preferred allocation in 5-year TIPS given we still think inflation will remain above the Fed’s 2% target this year. Read more in the full report below from Leslie Falconio and John Murtagh.

Shorting High Yield, a Difficult Fund Model On paper, shorting high yield makes sense until you’re actually running a HY book: 1) liquidity is thin, 2) short carry is costly, and 3) payoff profiles are skewed against you. If you get timing right for a systemic shocks or Black Swan event, then the payoff can be great, but the vast majority of well-reasoned short thesises underdeliver. Smaller funds with nimble capital can occasionally exploit dislocations, but scaling a strategy around HY shorts is structurally difficult. Did You Know? - It’s easier to buy or sell $1 billion of the high yield index than to move $50 million of a single-name HY bond—liquidity is concentrated in the index and in trading strips of index-like exposure, and not with sizeable exposure to a single constituent. - According to the Federal Reserve, the collective HY bond inventory across top Wall Street dealers (JPM, Citi, DB, BofA, Barclays, GS, MS, etc.) is effectively zero—down from ~$5 billion a decade ago. - The top 100 HY bonds trade as a synthetic index (e.g., HY CDX or HY44), offering liquidity and execution ease. In contrast, individual bonds often require $5 million+ lot sizes—not scalable for institutional shorting. - Funds earn most of their returns from the long side, clipping yields around 8%. The short side rarely produces consistent alpha, especially outside of event-driven trades. - The cost to short HY is punitive: ~4% for CDS, and 6–8% for cash bonds when accounting for coupons and borrow costs—often outweighing downside potential. - There are only 15 bonds in the HY market with over $3 billion in issuance per CUSIP—limiting size and tradability for big institutional positions. - Private capital is flush and ready to provide rescue financing, reducing default realizations and often cutting off the payoff path for short sellers—even when fundamentals crack. - The credit quality of HY has improved post-GFC, with a higher share of BBs and upgrades relative to leveraged loans. The relative value vs. broadly syndicated loans (BSLs) has eroded the bear case. - You can’t short leveraged loans, which are unlisted and illiquid. This removes a key hedging tool and limits the scope for credit shorting beyond bonds and CDS. - Banks prefer basket or thematic trades over single-name shorts. Examples might include BB vs. B ratings, airlines vs. cruises, builders vs. products, fallen angels vs. rising stars, and exporters vs. importers—letting PMs express relative value views rather than outright directional bets.

While tariffs and trade have driven stock markets this year, in recent weeks we have seen a shift in investor focus – to the bond market. Bond yields globally have been inching higher as debt and deficit levels are poised to climb. In the U.S., this comes as Moody's downgrades the U.S. credit rating, a new tax bill is passed by the House, and recent Treasury auction results have been mixed. Overall, we know rising debt levels can weigh on economic growth, as higher interest payments may crowd out more productive investments, like R&D and infrastructure spending. However, keep in mind a couple of mitigating factors as we consider the impact of elevated debt levels: 1) Historically, periods of higher debt/GDP have not coincided with higher yields – and in many cases it has been the opposite. 2) The old "TINA" adage likely still applies to the U.S. Treasury market – "There is no alternative": The U.S. Treasury market is one of the deepest and most liquid and regulated financial markets globally and still offers yield to economies, institutions and households at relatively low-risk. Read more in our Weekly Wrap authored by Angelo Kourkafas, CFA.

The US Fiscal Firehose: Why Bond Yields Are Watching Washington, Not Just the Fed Markets talk about the Fed. But yields? They’re watching Congress. You can see it in the numbers—deficits are now permanently high, even outside of crisis years. The US is projected to run 5-6% deficits through the next decade, and that’s before you include the likely extension of the Trump tax cuts. We’ve been here before—2008, 2020. Huge deficits, but yields dropped because of panic. This time’s different. No emergency. Just bad math. And the bond market is noticing. 10-year Treasury yields are hanging near 4.5%, even as inflation cools. Moody’s just joined S&P and Fitch in downgrading US credit. And the CBO says we could hit 216% debt-to-GDP by 2054. Here’s the takeaway: Fiscal policy is now a market risk. And the long end of the bond curve is acting like it knows it. This is no longer just a central bank story—it’s a fiscal one. Something investors (and allocators) need to actively watch. We cover this and more in our Nomura CIO Corner: https://lnkd.in/e4TCax_g Shoutout to Tathagata Bhar Anuragh Balajee Dhrumil Talati for their sharp inputs on the numbers and narrative. #CIOInsights #BondMarket #USTreasuries #FiscalDeficit #MacroLens #NomuraIWM #FixedIncome #DebtSpiral #MarketsWatchPolicy #CBOData

S&P Sovereign Rating: Fiscal consolidation, policy continuity and reforms brighten rating outlook • The ruling NDA got a weaker mandate in General Election 2024 compared to 2019 and 2014. However, a week before the election result was announced, rating agency S&P Global revised India’s sovereign rating outlook to ‘positive’ from ‘stable’, noting that regardless of the election result, it expected broad continuity in economic reforms and fiscal policies. While S&P retained India’s rating at BBB-, the outlook upgrade indicated that rating upgrade could follow in the next 24 months • In this series, we analyze global rating agencies’ criteria for sovereign rating and assess how India performs on the same. This report focuses on S&P’s Global’s sovereign rating criteria. Our analysis shows that: 1. The agency assesses sovereigns on five parameters viz. Institutional, Economic, External, Fiscal and Monetary. The first two form a country’s ‘Institutional and Economic Profile’ while the last three form its ‘Flexibility and Performance Profile’ o On ‘Institutional Assessment’, India scores 3, which as per the Agency’s definition indicates generally effective policymaking, evolving checks and balances and generally unbiased enforcement of contracts. On this pillar, India outperforms other BBB- rated countries o On ‘Economic Assessment’, India’s initial score is 5. This is mainly due to very low per capita income, indicating a narrow funding base that weakens creditworthiness. However, India’s faster trend growth compared to peer countries improves its initial score by one notch, taking the final score on this pillar to 4 o On ‘External Assessment’, India scores 1. S&P considers the INR to be an actively traded currency. Given India’s low external debt, on this pillar India far outperforms its peers and is on par with the likes of Germany, Singapore and Switzerland o The ‘Fiscal Assessment’ pillar is India’s Achilles Heel. High general government debt and high cost of debt servicing take India’s score to 6 on this pillar, significantly weaker than other BBB- rated countries and on par with defaulters like Lebanon and Sri Lanka. However, in the latest rating action S&P noted that may raise India’s rating if India's fiscal deficits narrow meaningfully such that the net change in general government debt falls below 7% of GDP on a structural basis. Along with fiscal consolidation, a negative interest rate-growth differential is likely to help India lower the debt burden. o On ‘Monetary Assessment’, India scores 3 outperforming BBB- rated countries. This indicates India’s ‘stabilized arrangement’ exchange rate regime, track record of central bank independence (albeit shorter), reliance on reserve requirements, and somewhat volatile REER Detailed report attached.