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. Past performance is not a guide to future performance.
After a tumultuous 18 months or so, signs are emerging that the headwinds from rising interest rates and soaring inflation are gradually dissipating.
For a start, we believe we are nearing the end of relentless hikes to US interest rates. Based on patterns of tightening cycles since the early 1970s, we think hiking will stop once rates move durably above inflation. This echoes comments by Fed Chairman Jerome Powell’s in September 2022: “You want to be at a place where real rates are positive across the entire yield curve.” With interest rates now at 5.25% and inflation gradually declining, we believe we have reached this very important juncture for the US economy.
Ultimately, the market outlook will depend on the inflationary scenario. Contrary to the views of many commentators, we consider the primary driver of the inflationary spike to be the vast amounts of liquidity that governments injected in the early days of the Covid crisis, and that central banks created as they lowered rates and implemented quantitative easing.
While the deceleration in money supply is now squeezing the excesses created, given the magnitude of previous stimulus measures, we expect it to take some time to bring inflation back down to its target of 2%.
The historically low levels of unemployment in the global labor markets will likely be another factor slowing the pace at which inflation falls. On the flipside, the high demand for workers against a relatively limited supply, especially in the US, lowers the chances of a hard landing for the global economy.
Finding new sources of value in global fixed income
Against this macro backdrop, investors can find attractive and diversified risk-adjusted returns within a wide range of government and corporate bonds, across IG and HY, and from developed countries to EM.
Government bonds
- The inflation spike has meant that US Treasury yields have broken out of their rangebound territory. A 30-year inflation-linked US treasury bond with a yield of 1.6% could generate 1.6% real return (i.e on top of realized inflation) over the long term. Source: Bloomberg, as of 31 May 2023. This type of instrument can serve as akin to an insurance policy for portfolios, given there will likely be bouts of volatility and inflation could remain stubbornly elevated in the near term.
- A similar boost to government bond yields can also be seen at the shorter end of the curve globally – including with five-year German Bunds and UK Gilts.
- With these opportunities in mind, we are finding that our unconstrained approach enables us to add duration within portfolios across regions, in turn helping investors capitalize on the benefits of changing bond yields and diversification. Further, based on our view that yields can only rise so far if inflation stabilizes, now seems a good entry point.
Corporate bonds
- Within the credit space, we think there is room for spreads to compress, so we generally see value in global IG corporate bonds. And with a total face value of over US$10 trillion in this asset class from around 2,000 issuers in diverse sectors (Source: ICE BoFA Global Corporate Index, as of 31 May 2023), it represents a formidable terrain for active managers such as ourselves to add value for our clients.
- In particular, for global investors hunting value, an allocation to European and UK corporate bonds has driven outperformance versus US corporate bonds in recent times. This is based on the appeal of European credits, with regional valuations in favour of European IG names compared with their US IG counterparts following the disruptions of 2022.
- From a sector perspective banking stands out in the more highly rated segment – especially with the larger institutions, which are well-capitalised and more resilient than in the past. In the BBB rated space, the utilities, media and telecom sectors are attractive at the moment.
High yield debt
- At the other end of the risk spectrum, HY fundamentals have held up relatively well to date.
- While corporate profitability (as measured by EBITDA growth) is normalizing post the COVID-19 rebound, measures of indebtedness such as total debt, net leverage and interest coverage remain at very strong levels.
- As a result, while default rates may increase at the margin given the prevailing high interest rate regime, we believe these will be manageable for skilled managers.
- In line with this, we see potential for HY exposure on a selective basis.
EM debt
- We see value today in EM local currency bonds, with the relative strength of real yields creating support for the asset class.
- This is a result of many EM central banks undertaking rate hikes earlier than the Fed, ensuring most EM real yields remain elevated compared with those in developed markets.
- This is a direct consequence of EMs learning from previous crises – notably the need to pre-empt Fed-led rate hiking cycles in developed markets that typically lead to capital outflows in EM due to monetary tightening.
Where next for fixed income?
In our view, the market sell-off of 2022 has opened up a unique opportunity for investors to seek exposure to fixed income assets and take advantage of attractive returns over the long term.
Saying that, and despite the inflation-fighting stance of central banks around the world, inflation remains the biggest risk for fixed income investors. To counter this, we believe an unconstrained bond approach enables investor 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.
|
To find out more about M&G Fixed Incomes strategies, contact |
|
| For Hong Kong readers, click here | For Singapore readers, click here |
For Institutional Investors and Accredited Investors in Singapore and Professional Investors in Hong Kong only. Not for onward distribution. No other persons should rely on any information contained within.
In Hong Kong, this financial promotion is issued by M&G Investments (Hong Kong) Limited. Office: Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong, and in Singapore, by M&G Investments (Singapore) Pte. Ltd. (Co. Reg. No. 201131425R), regulated by the Monetary Authority of Singapore. All forms of investments carry risks. Such investments may not be suitable for everyone. The information contained herein is provided for information purposes only and does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, and should not be relied upon as financial advice. For Hong Kong only: If you have any questions about this financial promotion please contact M&G Investments (Hong Kong) Limited. The contents of this document have not been reviewed by any regulatory authority in Hong Kong or Singapore.
