Day Hagan Smart Sector® Fixed Income Strategy Update April 2025
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Day Hagan Smart Sector® Fixed Income Strategy Update April 2025 (pdf)
Executive Summary
In March, policymakers acknowledged increased uncertainty regarding the economic outlook but maintained an expectation of a 50-basis-point reduction in interest rates for the year, consistent with their December forecast. GDP growth projections were revised downward from 2.1% to 1.7% for 2025, while 2026 and 2027 forecasts were adjusted to 1.8% (from 2%) and 1.8% (from 1.9%), respectively. Conversely, PCE inflation expectations for 2025 and 2026 increased to 2.7% (from 2.5%) and 2.2% (from 2.1%), while the forecast for 2027 remained at 2%. The unemployment rate estimate rose slightly to 4.4% from 4.3% for 2025, with the figures for 2026 and 2027 unchanged at 4.3%. Additionally, the Federal Reserve announced a reduction in the pace of diminishing its securities holdings, lowering the redemption cap for Treasury securities from $25 billion to $5 billion.
In early April, job growth optimism was tempered by escalating trade tensions, particularly following the U.S. administration’s imposition of 25% tariffs on imports from over 90 global trade partners and China’s retaliatory 34% tariffs on U.S. goods. These developments heightened fears of a trade war and caused notable volatility in global financial markets. Consequently, investors shifted towards safer assets, resulting in a decline in yields, with the U.S. 10-year Treasury note falling below 4%.
The Federal Reserve held the federal funds target rate steady at 4.25-4.50% during its March meeting, with Chairman Powell emphasizing a data-dependent approach to monetary policy. Nonetheless, the Consumer Confidence Index decreased to 92.9, the lowest since early 2021, influenced by growing concerns over rising prices linked to tariffs and a deteriorating economic outlook.
In the corporate bond market, investment-grade spreads widened, reflecting investor concerns about corporate earnings amidst intensifying trade disputes. Internationally, Germany’s increased borrowing for defense and infrastructure projects drove Eurozone government bond yields higher, amplifying worries about debt sustainability in countries like Italy and France.
Holdings
Fixed Income Sector
US 1-3 Month T-bill
US 3-7 Year Treasury
US 10-20 Year Treasury
TIPS (short-term)
US Mortgage-Backed
US Floating Rate
US Corporate
US High Yield
International Corporate Bond
Emerging Market Bond
Outlook (relative to benchmark)
Overweight
Overweight
Neutral
Neutral
Neutral
Underweight
Neutral
Neutral
Underweight
Underweight
Position Details
U.S. Treasuries: Entering April, the composite model improved. Measures of trend, momentum, and trend relative to U.S. equities are positive. Rising Credit Default Swap rates and stubbornly high inflation expectations are negative. We reduced exposure to longer-term maturities in favor of shorter-term maturities as Fed fund rate cut probabilities have increased significantly. On balance, we remain modestly overweight across the curve.
Commentary: Federal Reserve Chair Jerome Powell recently highlighted rising inflation risks and slow growth while maintaining a cautious approach to potential rate cuts. Market unease intensified after China’s finance minister announced a substantial 34% tariff on all U.S. imports, reflecting reciprocal actions following President Trump’s recent tariff implementation. Economists raised concerns about escalating prices, diminished growth, and the looming threat of recession, despite a March report that revealed U.S. job growth exceeding expectations with 228,000 new positions, significantly above February’s revised 117,000 and surpassing forecasts of 135,000. In this context, the dollar index remained near its weakest position in six months as traders balanced trade tensions against resilient job data. Speculation around Federal Reserve rate cuts increased, with traders now valuing a 50% probability of four 25-basis-point cuts this year, up from three earlier predictions, with an initial cut anticipated in June. Short-term Treasury yields, particularly the 2-year note, were primarily influenced by the Fed’s policy signals and immediate economic indicators. The central bank held the federal funds rate steady at 4.25%–4.50% in March, reflecting an environment of cautious monetary policy amidst inflation pressures. Conversely, long-term Treasury yields, such as the 10-year note, were shaped by broader economic concerns, especially following the announcement of significant tariffs, which prompted a flight to safety among investors. Consequently, the 10-year Treasury yield dropped below 4.0%, as recession fears grew.
U.S. TIPS: The April update remained neutral for the TIPS composite model. Measures showing declining commodity price trends, a renewed short-term technical uptrend, and wider option-adjusted spread values (causing investors to shift to TIPS) are positive. However, overbought indicators are negative, and inflation expectations are extended in the near term. We are neutral relative to the benchmark.
Commentary: Escalating trade tensions also impacted TIPS. Investors reacted by seeking inflation protection instruments such as Treasury Inflation-Protected Securities (TIPS), leading to a rise in the one-year inflation swap rate, which reached 3.07%. A reopening auction on March 20 for 10-year TIPS yielded a real return of 1.935%, slightly below 2%, but still demonstrating strong demand from investors. The inflation breakeven rate for this auction was set at 2.30%, reflecting market expectations for average inflation over the next decade. As a result, TIPS did well during the month. Overall, the interplay of trade tensions, Federal Reserve policies, and positive auction results highlighted a significant investor inclination towards inflation-protected securities amid economic uncertainties.
U.S. Mortgage-Backed Securities: Measures of trend, overbought/oversold, yield trends, and option-adjusted spreads remain positive for the sector. Relatively high inflation expectations are negative. We remain neutral. Note that this is the second largest sector within the iShares Core U.S. Aggregate Bond Index.
Commentary: The Federal Reserve is actively pursuing a strategy to reduce its balance sheet, specifically targeting agency debt and mortgage-backed securities (MBS) at a pace of up to $35 billion monthly. This process aims to normalize the Fed’s financial position but has contributed to diminished demand in the MBS market, potentially putting upward pressure on mortgage rates. In March, the announcement of new tariffs by the U.S. administration raised concerns over economic growth and inflation, prompting investors to seek safe-haven assets such as U.S. Treasury bonds. As a result, Treasury yields fell, influencing mortgage rates, which declined to about 6.63% for 30-year loans, positively impacting home affordability. We do note that outside of housing, commercial mortgage-backed securities experienced an increase in delinquency rates, approaching 9.8%, creating concern among investors and relative underperformance in March.
U.S. Floating Rate Notes: The composite model remains bearish, and trend, momentum, and swap rate indicators support the bearish outlook. The lone positive is the spike in the VIX (equity volatility) index, which indicates that stock market weakness may be close to stabilizing. If this reverses, it could encourage balanced account investors to sell bonds and buy equities, causing rates to increase. Currently, we remain underweight and will look to add exposure if equities stabilize.
Commentary: Floating rate notes (FRNs) experienced notable volatility in response to the Federal Reserve’s monetary policy. The Fed’s steady rate forecast directly affected FRN coupon payments, as they adjust with benchmark rates. The month saw increased market volatility, primarily due to trade tensions and policy uncertainties, leading to fluctuations in interest rates; notably, the 10-year Treasury yield experienced significant shifts mentioned earlier. This volatility prompted varied responses from analysts. The U.S. Treasury’s auction activity included offerings of 2-year FRNs, with auction announcements on March 20 and sales on March 26, indicating investor demand despite the prevailing interest rate landscape. Overall, the performance of FRNs in March 2025 was shaped by a neutral monetary policy and increased market volatility, which were negative for the sector.
U.S. IG Corporates: The composite model improved with the April update. Measures of implied bond volatility, option-adjusted spreads, trend, and mean reversion remain positive (though the move is more extended). The weaker U.S. dollar is negative, and the rise in Credit Default Swaps is concerning. The net result is a neutral allocation relative to the benchmark.
Commentary: The investment-grade bond market is experiencing a notable decline in new issuances as companies struggle to price bonds attractively, resulting in a significant rise in order cancellations during the book-building phase. Investor hesitance, fueled by concerns over tightening pricing and potential economic repercussions from trade policies, has led to a widening of credit spreads. According to the ICE BAML investment-grade index, this represents the most considerable increase in spreads since 2023, signaling higher risk premiums demanded by investors. The automotive sector is facing particular challenges, particularly following the announcement of 25% tariffs on imported vehicles, which triggered a sell-off in auto bonds. Major players such as Ford and General Motors have seen an increase in borrowing costs and investor apprehensions regarding profitability. In contrast, the financial and communications sectors are perceived to be less affected by these tariffs, suggesting a more stable outlook. A decline in U.S. exceptionalism, anticipating that protectionist measures may drive inflation higher and slow economic growth, is a concern. While there could be opportunities from widening spreads, the overall impact on most credit sectors, particularly automotive, could be significant.
U.S. High Yield: As equities go, so goes high yield. The model is negative, with measures of trend, breadth, small cap equity trends, and spreads supporting the negative view. We are underweight but will look to add if small-cap equities can stabilize and the model supports the action.
Commentary: A marked widening of credit spreads emerged as investor apprehension over a potential economic downturn grew, influenced by escalating trade tensions and recent tariff implementations. The gap between U.S. Treasury yields and junk-rated corporate bonds expanded to approximately 3.4 percentage points, the highest level in six months, signaling a heightened perception of risk associated with high-yield debt. The introduction of new tariffs, particularly a 25% levy on imported vehicles, severely affected the automotive sector. This led to increased selling pressure on bonds from major automakers, as investors feared rising costs and shrinking profit margins. In response to these developments, analysts expressed caution regarding high-yield investments, advising investors to reassess their portfolios in light of the prevailing uncertainties. The combination of widening credit spreads and fears of economic weakness urged stakeholders to adopt a more prudent approach to high-yield exposure, as volatility increased.
International IG Corporate Bonds: International Corporates had a good month in March. Entering April, measures of equity risk (VIX), relative strength, trend, and relative CDS trends were constructive (for International over U.S.). The widening of option-adjusted spreads is a headwind. We are now modestly underweight as credit deterioration is becoming more prevalent. Note: The International AG Bond sector is the fourth largest holding in the AGG at ~6.0%.
Commentary: The recent imposition of new tariffs by the U.S. administration has notably impacted emerging market corporations, with JPMorgan estimating that about 36% of more than 750 companies in the CEMBI emerging market corporate debt index are significantly affected. Industries such as industrials and metals & mining are particularly vulnerable. In Europe, the high-yield bond market is projected to see default rates climb to 5% in 2025, an increase from 3.3% in 2024, driven by the financial struggles of companies like Thames Water and Altice France. Conversely, European investment-grade bonds gained investor interest due to rising government spending on defense and infrastructure, particularly in Germany, leading to higher bond yields. On March 24, 2025, the European Commission held an EU-bond auction, successfully issuing bonds maturing in 2030 and 2044, totaling €4.744 billion with average yields of 2.805% and 3.786%. Perspectives from analysts indicate a decline in U.S. economic exceptionalism and highlight the importance of diversification into high-quality global bonds.
Emerging Market Bonds: EM bonds did well in February but underperformed U.S. bonds. However, measures of relative currency trends, EM equity momentum, commodity market strength, and trend-related indicators are now positive. We are increasing exposure.
Commentary: Recent escalations in global trade tensions have significantly impacted financial markets. The U.S. administration introduced a 10% universal tariff, accompanied by reciprocal tariffs ranging from 20% to 50% based on trade imbalances, especially affecting countries like China, the EU, and Japan, where tariffs exceeded 30%. This measure raised concerns of a potential trade war, leading investors to reevaluate their exposure to emerging markets. In response to these tensions, Fitch Ratings downgraded China’s long-term foreign currency credit rating from “A+” to “A,” citing rising government debt and increased fiscal risks. Projections indicate that public debt could rise from 60.9% of GDP in 2024 to 74.2% by 2026, impacting investor confidence in Chinese bonds. Conversely, Latin American assets have benefited from the situation, largely unaffected by U.S. tariffs due to their trade deficits with the U.S. As a result, investors have shifted towards Latin American stocks and currencies, with the MSCI Latin America index outperforming the S&P 500 by over 20 percentage points in 2025. Meanwhile, the People’s Bank of China maintained low lending rates to stimulate the economy amidst rising trade tensions.
Catastrophic Stop Model
The Catastrophic Stop model combines time-tested, objective indicators designed to identify high-risk periods for the equity market. The model (Figure 1) held steady in March and entered April supporting a fully invested position. Technical measures calling U.S. Stock/Bond Relative Strength, Short-term Trend, Intermediate-term Trend, and High Yield OAS spreads are bearish. Conversely, global breadth statistics, sentiment, measures of economic activity, and equity demand remain bullish. Long-term oversold mean reversion indicators and High Yield/EM Bond breadth are neutral. Our indicators have not yet registered an intermediate-term breadth thrust. Breadth thrust signals don’t necessarily need to occur for the markets to mark a low, but they do increase the probability that a broader-based uptrend will be sustainable.
The weight of the evidence suggests that the current decline is not expected to extend into a significant downtrend. Of course, if our model flips to negative (below 40% for two consecutive days), signaling more substantial problems, we will raise cash immediately by selling a portion of our fixed income holdings with the highest correlations to equity performance.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk and where to place that capital.
For more information, please contact us at:
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Smart Sector® Fixed Income ETF
Symbol: SSFI
Disclosures
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