With higher yields, declining inflation and the end of the interest rate hiking cycle in sight, fixed income continues to offer an attractive entry point for investors. From high-quality government bonds and corporate credit, to emerging market (EM) local currency bonds and even some high yield (HY), investors seeking value should be flexible in their allocations.
Where next for fixed income?
A global economic snapshot
- The market is pricing in an end to the US Federal Reserve’s (Fed’s) interest rate hiking cycle over the coming months.
- Efforts by governments and central banks around the world to reign-in excess liquidity have led to a sharp deceleration in money supply. This is expected to push inflation lower, albeit slowly.
- Tight labour markets should ultimately reduce the chances of a hard landing for the global economy. Yet the high demand for workers against a relatively limited supply, especially in the US, could further slow the pace of declining inflation.
Opportunities across the fixed income landscape
- In general, higher yields and inflation levels under control represent a good entry point into fixed income. However, a flexible approach when allocating to these assets is increasingly important amid continued uncertainty due to the shifting macro backdrop.
- For government bonds – the inflation spike over the past 12 months has boosted their appeal at both the longer and shorter ends of the yield curve, putting the risk/return ratio increasingly in investors’ favour.
- For investment grade (IG) corporate credit – with expectations that spreads may compress, value investors can find opportunities in specific parts of the market, including the banking, utilities, media and telecom sectors. Being overweight BBB European credit, for example, has led to outperformance over US credit.
- For HY debt – robust fundamentals, stemming from expectations of relatively resilient corporate profits over the next 12 months, plus current low leverage levels, suggest an appealing starting point for HY investors on a selective basis.
- For EM local currency bonds – The combination of strong and positive real yields – certainly compared with developed markets – has been supportive for this asset class. These bonds have benefited from the decision by many EM central banks to pre-empt the Fed’s rate hiking action.
- An unconstrained bond fund enables investors to capitalise on the range of potential opportunities in global fixed income by adjusting exposure to instruments that offer the most compelling risk/return characteristics at different points of the economic cycle.