The economy has shown resilience in the face of rising interest rates, with inflation moderating in the second quarter. Core CPI and core PCE, the Federal Reserve’s preferred measure of inflation, fell to levels not seen since 2021, indicating some success in the Fed’s efforts to combat inflation. Despite this progress, Fed officials remain cautious, emphasizing the need for patience and data dependency in their decision-making.
The labor market, however, has weakened in recent months, with unemployment rising and job openings falling. Wage gains have also slowed, and the voluntary quits rate has decreased. This shift in the labor market dynamics has increased the risks of monetary policy decisions, making it a more nuanced proposition.
In the fixed income markets, yields rose in April before falling back in May and June. The 2-year Treasury yield ended the quarter up 14 basis points, while the 10-year and 30-year yields increased 20 and 21 basis points, respectively. Corporate credit spreads narrowed, and high-yield bonds outperformed.
The MetWest Investment Grade Credit Fund gained 0.68% in the quarter, slightly underperforming its benchmark. The fund’s duration positioning was longer than its benchmark, which benefited relative performance in May and June but was a headwind in April. The fund’s overweight to agency MBS was also rewarded in May and June, while its underweight to corporate credit was a drag on performance.
Looking ahead, the fund’s managers expect the economy to slow, and the Fed to keep rates too high for too long, leading to a sharp steepening of the yield curve. As such, the fund is positioned with a longer duration and an emphasis on front-end and intermediate yields. The managers also remain cautious on corporate credit, preferring higher-quality exposures and industries that are less sensitive to consumer discretionary spending.
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