Fourth Quarter 2023

We enter 2024 with the U.S. monetary policy tightening cycle in the rearview mirror. From a fundamental perspective, the directional move lower in interest rates is consistent with our view that the Fed will be in a position to reduce Fed funds because inflation is well past the extreme levels it reached earlier this cycle. We also believe growth will slow, with recession still a possibility. By acknowledging its progress with prices and reducing the degree of restrictive policy, the Fed can alleviate the pressures building from sharply higher rates.

The rapid reversal in market rates may not fully reflect uncertainties that are on the horizon. This includes disruptions from geopolitical frictions that could slow or even pause pace of disinflation. Concerns about fiscal discipline and a surge in U.S. Treasury supply could also re-emerge, especially as we get closer to the fall elections. We expect 10-year yields to trade in a wide range of 3.00% – 4.50%, with greater choppiness in the early part of the year.

We are comfortable with a modest overweight to Credit despite rich valuations for Long Corporates. Modest supply paired with strong demand from yield seeking investors creates technical tailwinds that have been the dominant driver of returns in the Corporate sector. We do not expect these trends to weaken in the near term. Gross new issuance of investment grade Corporates is expected to be in line with last year, around $1.3 – $1.4 trillion. BBB-rated supply should remain limited for a number of reasons including lower issuance and upwards ratings migration. Long duration supply will be constrained by muted refinancing needs and the reluctance to lock in higher borrowing costs.

That said, the significant decrease in Corporate spreads across the curve has made us even more selective on where to take risk in the portfolios. We view credit fundamentals as exhibiting late-cycle characteristics and the macro risks are still elevated which could lead to increased spread volatility. Credit metrics, on the margin, have been moderating. However, management teams are demonstrating financial discipline that benefits investors in investment grade bonds. We will lean on selection as we expect bottom-up analysis to be paramount to performance given current valuations.

The Securitized sectors present more opportunities to create alpha from both allocation and selection. Mortgage spreads repriced modestly lower but lagged the Corporate sector as last year’s banking crisis dried up demand from key investors in the space. With that retrenchment largely over, we believe Mortgages have an attractive forward risk return profile relative to both U.S. Treasuries and Corporates. Non-agency CMBS continue to offer potential to identify inefficiently priced securities as commercial real estate stress further plays out, particularly in the office sector. Last year we opportunistically traded the sector. This year, we look to build a more persistent exposure to the space. For ABS, we like the structural protection of these securities and spreads compensate investors well for any apparent weakness in the household sector.


Past performance is not a guarantee or a reliable indicator of future results. Investing involves risk; principal loss is possible. Investors should carefully consider risk when investing in bonds or other securities, which include, but are not limited to, default, credit rating, interest rate, duration, prepayment, liquidity, and structural risks. Securities are also subject to general market risks due to factors that affect the overall market, which may include, but are not limited to, government actions, investor behavior, and economic conditions. Economic conditions may be influenced by liquidity risk, geopolitical risks, monetary and fiscal policy, interest rate risk, and inflation, among others. There is no guarantee that investment strategies presented will work under all market conditions. Risk management processes including diversification cannot eliminate the risk of losses nor assure the likelihood of a gain. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn or volatility in the market. Refer to the Legal & Disclosures section for additional disclaimers and disclosures regarding performance, risk, and investment process.

Information presented is for informational purposes only. It is not intended as investment advice nor an opinion or a recommendation as to the appropriateness of investing in any particular security, asset class, strategy, or product. Nothing in this publication is intended to be relied upon as a forecast or research; legal, tax, securities, or investment advice. Nothing in this publication is a solicitation of any type.

This commentary contains Pugh Capital’s opinions based on the information available at the time of the analysis. Opinions, outlook, and strategies are subject to change without notice. Statements concerning financial market trends are based on information available and current market conditions which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

This report is intended for U.S. institutional investors only. No part of this material may be modified, distributed or duplicated without the explicit permission of Pugh Capital Management.

Source: Pugh Capital, Bloomberg, and Bloomberg Indices.

As of December 31, 2023.