Fixed income as an asset class
Fixed income is the asset class comprising debt securities — bonds, notes, bills, and other instruments where the issuer promises predetermined cash flows. The name comes from the fixed coupon payments most bonds make, though in practice the "fixed income" label applies to the broader debt market including floating-rate instruments.
Fixed income is larger than equity markets globally. Governments alone issue trillions in debt annually. US Treasuries outstanding exceed $25 trillion. Corporate bonds, mortgage-backed securities, municipal bonds, and emerging market debt add trillions more. This scale makes fixed income the backbone of global finance.
For equity traders, fixed income matters primarily because bond yields influence equity valuations (through the discount rate), because yield movements signal economic expectations (the yield curve), and because the relationship between bonds and equities tells you about the risk regime.
Short-term rates are controlled by the central bank (Fed Funds Rate). Medium rates are heavily influenced by Fed policy expectations. Long rates (10-30 year) are shaped by long-term growth and inflation expectations, supply/demand dynamics, and global investor flows. These three can diverge, creating different curve shapes.
Types of fixed income securities
Investment-grade corporate bonds (rated BBB-/Baa3 and above) are issued by financially stable companies. They pay a yield premium over Treasuries (the spread) to compensate for the additional credit risk. Investment-grade spreads widen when economic risk rises and tighten when conditions are healthy.
High-yield (junk) bonds (rated below BBB-) carry significantly higher credit risk and pay higher yields. HYG and JNK are the main ETF proxies. High-yield spreads are the most sensitive early warning system for economic stress — they widen before equity markets fully reflect the deterioration.
Mortgage-backed securities (MBS) pool residential mortgages and sell the cash flows as bonds. Agency MBS (backed by Fannie Mae, Freddie Mac) are considered near-government quality. Private-label MBS carry credit risk. MBS spreads are sensitive to interest rates in complex ways because of prepayment optionality.
The bond-equity relationship
In normal conditions (low-to-moderate inflation), bonds and equities have a negative correlation — when equities sell off (risk-off), Treasuries rally (safe haven buying). This negative correlation is why the classic 60/40 portfolio (60% equities, 40% bonds) diversifies well in normal environments.
The correlation can flip in high-inflation environments. In 2022, both bonds AND equities fell sharply because the primary driver was rates rising to fight inflation — bad for both asset classes simultaneously. Understanding when the bond-equity correlation is likely to be positive versus negative is crucial for risk management.
The 10-year / 2-year yield spread (often called "the yield curve") is the most watched relative rate relationship. When 10-year yields are above 2-year yields (positive curve), the market expects growth. When 2-year yields exceed 10-year yields (curve inversion), the market is pricing in a future rate-cutting cycle — historically a reliable recession precursor.