Fixed income 2023: Ripe for a reversal
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By: Amar Reganti, Fixed Income Strategist; Jonathan Tan, CFA, Investment Specialist; Adam Norman, Investment Communications Manager
There’s no sugarcoating it: Last year was rough sledding for bond investors. High-grade fixed income markets experienced their worst-ever calendar year in 2022, 1 driven by sharply higher sovereign bond yields as global central banks supercharged their rate-hiking cycles in an effort to rein in persistent inflationary pressures ( Figure 1 ). Credit spreads across most fixed income sectors widened, significantly in some cases, amid concerns that tighter financial conditions created by less accommodative monetary policy could tip the global economy into recession. High-quality bonds that have traditionally offered investors a measure of protection in challenging market environments instead posted some of last year’s most disappointing total returns.
Figure 1
However, this year is shaping up to be a decidedly different story. We believe last year’s interest-rate moves and asset-price declines have spawned a potentially compelling investment opportunity set for risk-conscious fixed income market participants. The early 2023 market rally notwithstanding, we expect multiple good price entry points (along with some volatility) to show up over the rest of the year.
Now is not the time to give up on fixed income
Rising stock/bond correlations in 2021 and 2022 seemingly left no place for investors to hide from market volatility. So, are frustrated investors to conclude that fixed income has lost some of its proven ability to defend principal and diversify other portfolio risks? We don’t think so. Despite fixed income’s prolonged slump through 2022, we remain confident in the power of this cornerstone asset class to retain its key role as a portfolio diversifier and equity downside mitigator in risk-off market environments.
Clearly, that was not so last year — a striking anomaly, in our view. Fixed income exposure in the form of interest-rate duration typically acts as a counterweight to other risks in investor portfolios. For example, periods of risk aversion that tend to negatively impact risk assets such as equities have historically often seen bond prices rise. In 2022, however, aggressive global central bank monetary policy tightening pushed yields up across the yield curve in most developed markets. 2 The result: Bond prices fell along with equity values, with yields across many high-grade fixed income sectors reaching their highest levels since the early stages of the 2008 – 2009 global financial crisis ( Figure 2 ).
But it’s important to remember that fixed income investors may stand to benefit from prevailing higher yields over multiyear time horizons. While the recent sharp increase in bond yields has been painful for many investors in the short term, we believe it can ultimately serve to enhance fixed income’s longer-term income generation and total-return prospects. Today’s loftier yields may also offer investors better entry points into some fixed income assets, along with a potential cushion against further interest-rate volatility in the months ahead.
Figure 2
Favor high-grade fixed income amid recession risks
We believe high-grade fixed income in particular features an appealing risk/reward profile these days: “All-in” yields were recently perched at relatively attractive thresholds, including credit spreads wider than their long-term historical medians...
