Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Access all our platforms from a single account.
Fixed income: Keep calm, seize the moment
Quarterly Outlook
Althea Spinozzi
Head of Fixed Income Strategy
Summary: With the economic slowdown, quality assets will gain favor, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Rate cuts are coming for bonds
A slowdown in economic growth and a gradual decrease in inflation will give central banks the opportunity to dial back on their tight monetary policies and implement rate cuts as soon as in the second quarter of the year, building the case for a portfolio's extension in duration.
Despite this, investors should refrain from getting too much exposure to bonds with ultra-long maturities as inflation remains above the 2% target. Monetary policies in developed markets will start to diverge in terms of balance sheet unwinding. In addition, the Fed will slow the pace of Quantitative Tightening (QT) to avoid a liquidity squeeze, and the ECB will accelerate it, beginning to runoff the Pandemic emergency purchase programme (PEPP) in June. This is likely to result in higher volatility in bond yields, especially in the longer part of yield curves.
Following a broad, cross-market rally over the past two quarters, markets might be underestimating both the upside and downside risks to the economy. The good news is that fixed income markets currently provide a variety of opportunities that can withstand multiple macroeconomic scenarios, thanks to attractive bond valuations and yields that are around their 15-year highs.
Despite fiscal concerns, sovereign bonds continue to demonstrate their value as a portfolio hedge against growth and financial risks, with the front part of the yield curve offering a win-win solution.
Fixed income views
The Fed and ECB are likely to begin cutting rates around summer. Yet, policymakers will reinforce the message that they remain data driven and will proceed slowly as inflation remains above the 2% target.
If rate cuts do not materialise, a hard landing becomes more probable, particularly in the Euro area, where the economy has been stagnant since December 2022.
Investment-grade corporate bonds
Credit deterioration will accelerate as the economy slows, resulting in rating downgrades. Excluding pandemic highs/lows, investment-grade corporate bonds currently have the highest leverage on record, and the lowest investment coverage since the global financial crisis, making bottom-up analysis and cherry picking crucial.
High-yield corporate bonds
The high-yield corporate space is facing a double hurdle: deteriorating fundamentals, and increasing refinancing risk, as they approach a wall of maturities in 2025. Yet, as central banks prepare to ease financing conditions, junk bonds are likely to remain underpinned.
Investment implications
As the Federal Reserve and the ECB prepare to cut rates, there is scope to extend a portfolio’s duration up to 10 years.
Developed markets front-term rates have peaked in 2023 and offer a win-win scenario for medium-term and long-term holders. As an example, assuming a 6-month holding period, 2-year US Treasury yields need to rise above 6.1% to provide a negative return.
US long-term rates remain vulnerable to the pace of inflation returning to 2%, and a possible rebound in term premium. In case of a slower than expected disinflation trend, yields of US Treasuries with maturity more than 10 years might rise further despite the Fed beginning to cut rates. In Europe, long-term rates are fair, but we remain cautious on ultra-long maturities.
Investment-grade corporate bonds
Despite credit fundamentals deteriorating, investment-grade credit spreads will remain range bound as investors rotate from risk to quality.
High-yield corporate bonds
High-yield spreads are likely to widen gradually amid a slowing economy. Yet, demand is likely to remain robust as, on average, junk bonds on both sides of the Atlantic pay a yield above the past 14 years’ average.
Latest Market Insights
Quarterly Outlook
-
-
Quarterly Outlook
Equity Outlook: Will lower rates lift all boats in equities?
Peter Garnry
Chief Investment Strategist
After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto... -
Quarterly Outlook
FX Outlook: USD in limbo amid political and policy jitters
Charu Chanana
Chief Investment Strategist
As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ... -
Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c... -
Quarterly Outlook
Commodity Outlook: Gold and silver continue to shine bright
Ole Hansen
Head of Commodity Strategy
-
Quarterly Outlook
FX: Risk-on currencies to surge against havens
Charu Chanana
Chief Investment Strategist
Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo... -
Quarterly Outlook
Equities: Are we blowing bubbles again
Peter Garnry
Chief Investment Strategist
Explore key trends and opportunities in European equities and electrification theme as market dynami... -
Quarterly Outlook
Macro: Sandcastle economics
Peter Garnry
Chief Investment Strategist
Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p... -
Quarterly Outlook
Bonds: What to do until inflation stabilises
Althea Spinozzi
Head of Fixed Income Strategy
Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ... -
Quarterly Outlook
Commodities: Energy and grains in focus as metals pause
Ole Hansen
Head of Commodity Strategy
Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...