Inflation pressures and fiscal risks shape bond markets

Persistent inflation, resilient employment, uneven credit performance and rising government debt are sustaining upward pressure on interest rates and shaping fixed-income positioning.

• Core goods prices rose for a fourth consecutive month in September, while October core PCE inflation was estimated at 3.3% year over year.
• U.S. nonfarm payrolls increased by 165,000 in October, with gains spanning construction, manufacturing, trade, transportation, utilities and professional services.
• The 2-year to 10-year Treasury spread narrowed from about 70 basis points at the start of the year to around 30 basis points as short-term yields rose more sharply.
• October investment-grade spreads widened by 21 basis points in technology and 34 basis points in communications, versus 6 basis points for the broader index; Caa spreads widened by 109 basis points, compared with 29 basis points for Ba bonds.
• U.S. government debt is about 101% of GDP and could reach 120% within a decade and 175% over 30 years, according to Congressional Budget Office projections.

Takeaway: Russell Investments expects one further rate hike in December, followed by a possible pause or additional hike in January, and favors higher-quality credit with negative to low spread duration while monitoring Treasury demand, productivity and investor confidence.