Day Hagan Smart Sector® Fixed Income Strategy Update June 2025
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Day Hagan Smart Sector® Fixed Income Strategy Update June 2025 (pdf)
Executive Summary
Fixed income markets exhibited varied performance in May, driven by divergent macroeconomic factors, dashed expectations of more dovish Federal Reserve policy, and sector-specific dynamics. Performance ranged from weakness in U.S. sovereigns to outperformance in emerging market bonds.
Treasury Inflation-Protected Securities (TIPS) saw moderate gains, as elevated inflation expectations, fueled by sticky wage growth and tariff concerns, supported demand; however, deflationary risks capped the upside. Agency Mortgage-Backed Securities outperformed other sectors, benefiting from strong consumer credit, wider yield spreads, and reduced securitization rates, which stabilized valuations amid tariff-induced volatility. Floating Rate Notes thrived due to their linkage to short-term rates, such as SOFR, offering resilience against anticipated Fed rate stability. U.S. Investment Grade Corporates faced limited upside from tight credit spreads, though robust fundamentals ensured modest returns despite tariff uncertainties. U.S. high-yield bonds performed well, supported by low default rates and policy-driven strength in sectors like Healthcare and Energy. International Corporate Bonds struggled with rising U.S. yields, though European stability offered some relief. Emerging Market Bonds showed resilience, driven by favorable supply-demand dynamics and selective opportunities in countries with strong fundamentals.
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)
Neutral
Neutral
Neutral
Underweight
Neutral
Underweight
Underweight
Overweight
Neutral
Overweight
Position Details
U.S. Treasuries: Entering June, the composite model rebounded from the May lows but remained neutral on balance. Measures of momentum, trend, and rising inflation expectations are negative. Conversely, positive equity performance and a peak and subsequent reversal in credit default swap rates are bullish. The net result is a neutral allocation.
Commentary: U.S. Treasuries were affected by rising inflation expectations, driven by persistent wage growth and tariff-related price pressures, pushing Treasury yields higher, with the 10-year note climbing toward 4.5. Uncertainty surrounded Federal Reserve policy, with markets anticipating sustained higher rates, adding volatility. Stronger economic growth signals supported demand for equities, which is generally supportive of corporate fixed income sectors. Tariff announcements sparked brief selloffs and widening yields. Meanwhile, foreign demand slowed. Overall, inflation fears, a weaker U.S. dollar causing foreign investors to focus on other countries’ debt, Fed expectations, and trade policy uncertainties were key drivers.
Figure 1: Trends in inflation expectations have historically been very useful in calling fixed income trends.
U.S. TIPS: The TIPS composite model remains in negative territory, even with rising inflation expectations. This dichotomy is explained by investors expecting a transitory inflation backdrop. Indicators calling overbought/oversold, longer-term inflation expectations, commodity price trends, and high-yield option-adjusted spreads are bearish. We are underweight.
Commentary: TIPS saw moderate demand as investors sought hedges against persistent inflation pressures. Sticky wage growth and tariff-related price increases kept near-term inflation expectations elevated, supporting the relative performance of TIPS despite rising Treasury yields. However, potential deflationary risks limited upside, as TIPS yields typically lag conventional bonds in such scenarios.
Figure 2: Weaker commodity prices often lead to lower inflation pressures.
U.S. Mortgage-Backed Securities: The composite model remained neutral, with measures of credit spreads and short-term trends negative. The backup in 10-year yields is negative for MBS, as are higher inflation expectations in the near term (though there is less prepayment risk as yields remain sticky). We are neutral, in line with the model’s message.
Commentary: Agency MBS outperformed investment-grade and high-yield sectors (though it was still negative) amid tariff-driven market volatility. Strong consumer credit fundamentals and higher yield spreads compared to traditional corporates bolstered MBS appeal. Reduced securitization rates and increased bank retention of mortgages further stabilized valuations, enhancing risk-adjusted returns.
Figure 3: Rising longer-term yields’ positive impact wanes when buyers are forced out of the market as yields get too high. A rise above the blue line and reversal back through would be bullish.
U.S. Floating Rate Notes: The composite model moved higher mid-month but ultimately declined back to levels seen at the beginning of May. The model’s indicators are mixed, leaning negative, with short-term trend and momentum holding onto their positive signals, while volatility measures, OIS Swap rates, and the intermediate-term trend indicator are negative. We are underweight.
Commentary: U.S. Floating Rate Notes (FRNs) outperformed in May, driven by their linkage to short-term rates like the Secured Overnight Financing Rate (SOFR). Persistent inflation and expectations of sustained high Federal Reserve rates bolstered FRN appeal, with coupons adjusting upward to mitigate interest rate risk. Tariff-related market volatility increased demand for FRNs as a hedge against fixed-rate bond price declines. Strong economic growth and robust investor appetite for yield further supported performance. Limited new issuance supported returns for FRNs.
Figure 4: As inflation expectations wane, FRN’s are under more pressure.
U.S. IG Corporates: The composite model is underweight, with indicators calling the U.S. dollar (weakness), short-term trend (negative), implied bond volatility (high), and price mean reversion trying to stabilize. However, those indicators remain on sells. We do note that option-adjusted spreads and CDS have reversed from higher levels as equity markets gained their footing.
Commentary: Tight credit spreads and macroeconomic uncertainties. Strong corporate fundamentals, including healthy balance sheets, supported demand; however, tariff announcements sparked volatility, tempering the spread tightening. Rising Treasury yields, driven by persistent concerns about inflation, pressured bond prices. However, robust investor appetite for yield in a high-rate environment provided stability. Overall, tariff uncertainties, elevated yields, and resilient fundamentals shaped the performance of investment-grade corporates.
Figure 5: U.S. dollar weakness is a headwind for U.S. assets.
U.S. High Yield: The composite model reversed to overweight; as equities go, so goes high yield. Measures of trend, relative volatility, small-cap equity trends, and high-yield bond breadth are bullish.
Commentary: U.S. High Yield Bonds outperformed in May, driven by resilient fundamentals and sector-specific strength as well as a low default rate of 1.5%. Tariff-induced volatility briefly widened spreads, but strong corporate earnings in Healthcare and Energy bolstered returns. Investor demand for higher yields amid a volatile Treasury market saw spreads stabilizing. Positive trade developments and robust fundamentals, despite tariff concerns, underpinned high yield’s attractive performance.
Figure 6: High yield bond breadth has been bullish, but we are monitoring this indicator for signs that the support is wearing off.
International IG Bonds: Following last month’s model improvement, the model reversed back to a neutral reading. Relative trend and volatility indicators are positive, but option-adjusted spreads and CDS levels have yet to confirm. We remain neutral.
Commentary: Positive trade developments led to slightly positive returns, with spreads tightening, though currency risks dampened USD-based returns. Given the volatility last month, investors favored higher-quality bonds amid uncertainties surrounding tariffs. European bonds benefited from anticipated ECB rate cuts, but volatility from U.S. trade policies limited gains, creating a challenging yet selective environment for global corporates.
Figure 7: CDS for International IG bonds are starting to move higher.
Emerging Market Bonds: The EM bond model improved again with the June update. Trend, currency, relative strength, and EM equity momentum are bullish supports. The lone negative is the model’s commodity price factor, which has been stagnant over the past six months, reflecting less-than-robust economic activity. The net result is an overweight allocation.
Commentary: Emerging Market Bonds outperformed in May, driven by slightly better macro conditions and regional opportunities. Positive fund flows and tight supply fueled some of the gains. There was evidence of strengthening fundamentals in bonds from Brazil (now one of our Explore holdings in the Smart Sector International strategy) and South Africa. Although volatility was higher than average, demand for high-yield bonds from stable economies like Mexico emerged. A weakening dollar mitigated rising Treasury yield pressures, enhancing returns for riskier emerging market bonds.
Figure 8: Emerging Market equity momentum has supported EM bond prices. A decline below the 0 line would lead us to reduce exposure.
Catastrophic Stop Model
The Catastrophic Stop model combines time-tested, objective indicators designed to identify high-risk periods for the equity market. The model entered June recommending a fully invested equity allocation relative to the benchmark.
The Catastrophic Stop model level increased to 77.27% as of Friday, May 30 (where 0 represents the worst conditions and 100 represents the best). Measures calling breadth thrusts (periods of high demand), reversals from extreme oversold conditions, volume supply vs. demand, high-yield credit spreads (OAS), economic activity, and high-yield bond breadth are bullish. The Day Hagan Daily Market Sentiment Composite has moved further into the excessive optimism zone. This is not unusual after significant declines; historically, the model has often shown extreme pessimism that quickly transitions into excessive optimism. We interpret this rapid movement similarly to a “breadth thrust.” With sentiment indicators, we go with the flow until it reaches an extreme and reverses. In other words, we will rate this indicator as neutral until it reverses back below 70.
The weight of the evidence suggests that the recent decline is not expected to extend into a significant downtrend. Of course, if our model flips negative (below 40% for two consecutive days), signaling more substantial problems, we will raise cash immediately in credit sectors closely correlated with equity trends.
Figure 9: The Catastrophic Stop model recommends a fully invested fixed income position (relative to the benchmark). Note: The model’s levels prior to 5-1-2025 have been archived. As of that date, the model was modified to include Breadth Thrust and Oversold Mean Reversion clusters. Due to the use of indices to extend model history, the model is considered hypothetical.
Figure 10: S&P 500 Index vs. Day Hagan Daily Market Sentiment Composite
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. Currently, the uptrend remains intact. The broader-based composite models calling U.S. economic growth, international economic growth, inflation trends, liquidity, and equity demand remain constructive. The Catastrophic Stop model is positive, and we are aligned with the message. If our models shift to bearish levels, we will raise cash.
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:
Day Hagan Asset Management
1000 S. Tamiami Trl
Sarasota, FL 34236
Toll Free: (800) 594-7930
Office Phone: (941) 330-1702
Website: https://dayhagan.com or https://dhfunds.com
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Day Hagan Smart Sector® Fixed Income ETF
Symbol: SSFI
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The data and analysis contained within are provided "as is" and without warranty of any kind, either express or implied. The information is based on data believed to be reliable, but it is not guaranteed. Day Hagan DISCLAIMS ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY, SUITABILITY, OR FITNESS FOR A PARTICULAR PURPOSE OR USE. All performance measures do not reflect tax consequences, execution, commissions, and other trading costs, and as such, investors should consult their tax advisors before making investment decisions, as well as realize that the past performance and results of the model are not a guarantee of future results. The Smart Sector® Strategy is not intended to be the primary basis for investment decisions and the usage of the model does not address the suitability of any particular in Fixed Income vestment for any particular investor.
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