Navigating the Investment Landscape in the Year of the Dragon: Bond Market Insights

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The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.

As we step into the year of the Dragon in 2024, the bond market reflects a series of changes that have occurred over the past year. 2023 had mostly been a period of adjustment and adaptation, with the closing weeks of the year ushering in a sense of calm following a turbulent start of the year. The remarkable rally in both bond and equity markets was spurred by a notable decrease in inflation figures. These decreasing price pressures confirm the continuation of the disinflationary trend that began in late 2022.

The decrease in inflationary pressures has had a cascading effect, leading to a significant decline in government bond yields. For instance, 10-year US Treasury yields, which briefly peaked at 5% in October, have now rallied to below 4%. This represents the largest government bond rally since the COVID-19 crisis. The declines in yields of German Bunds and UK Gilts have also been notable. Investors have responded by significantly adjusting their expectations, bringing forward predictions of rate cuts in 2024.

Inflation Dynamics: Finding Stability

While recent data points suggest a decrease in inflation, we must approach these trends with caution and avoid overreacting to short-term fluctuations. The decline in inflation, though overdue, represents a step towards stability. The tightening of monetary policy by the US Federal Reserve has gradually brought inflation back towards its 2% target, aligning with our expectations.

Government Bonds in the Year of the Dragon

Over the past year, government bonds emerged as a sanctuary amidst the uncertainty. Government bonds such as US Treasuries, UK Gilts and German Bunds garnered increased attention due to their relatively attractive yields, with the shift in sentiment being attributed to the decrease in inflation and the resulting drop in government bond yields. As we look ahead into the horizon of 2024, we remain constructive on bond markets. We maintain a slight preference for government bonds over corporate bonds, given that government bond yields continue to remain relatively elevated by historical standards. Moreover, central banks appear to disregard the sharp fall in the money supply, which we view as a potential deflationary force. While we acknowledge the possibility of a “soft landing” for the global economy, we keep a watchful eye on economic data for signs of either overly tight monetary policies or delayed interest rate normalization.

Corporate Bonds: Adapting to the Dragon’s Roar

Corporate bonds have undergone a transition from being considered relatively good value to moving closer to what we consider “fair value". Our current inclination leans towards investment-grade bonds over high-yield options. High-yield corporate fundamentals have held up reasonably well, thanks in part to robust consumption and pre-emptive corporate refinancing that has allowed issuers to extend their maturity profiles at attractive rates. However, as developed economies begin to slow and higher rates starts start affecting corporate balance sheets, there is a possibility of an uptick in default rates.

In response to these uncertainties, we have prudently reduced our overall exposure to more speculative corporate bonds in our flexible strategies. We remain confident that active managers can identify market dislocations and generate alpha for our clients.

Emerging Market Debt: Riding the Dragon’s Tailwind

Emerging market (EM) debt has proven resilient in the face of the fastest US hiking cycle in decades. As we enter 2024, the asset class is poised for a potential resurgence in investor interest. EM central banks demonstrated agility by swiftly increasing base rates in response to inflationary pressures, with Latin America leading the way in 2023.

This regional divergence influenced our preference for Latin America over Asia, along with the allure of more attractive valuations. Opportunities arise as we consider selling well-performing assets and reallocating resources to regions where we have had underweight positions. Bond yields in emerging markets, while elevated relative to their levels during the 2020 COVID sell-off, still have room for further spread compression, especially within government bonds.

2024 Outlook: Charting a Steady Course

In conclusion, the year of the Dragon in 2024 presents opportunities in government bonds and duration (interest rate risk). Valuations have become more favourable, aligning with shifts in inflationary expectations and central bank interest rate decisions. While we remain cautiously optimistic about a ‘’soft landing’’ for the global economy, we acknowledge potential downside risks to growth and inflation that warrant continuous monitoring. 

Our approach towards corporate bonds is prudently conservative, emphasizing value through security selection and maintaining flexibility to respond to future market dynamics. The year of the Dragon will symbolize a journey marked by adaptability and resilience in the investments world, reminding investors to maintain a steady course amid the Dragon’s breath of uncertainty.

*This article was first published, in Chinese, in the Hong Kong Economic Journal.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.

The content of this page reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. All information included in this page has been written for informational and educational purposes only and does not constitute an offer or solicitation to invest into any security, strategy or investment product. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents.