Fixed-income experts see interesting prospects emerging as some bond market pressures begin to ease
2022’s high inflation and forceful central bank action brought subpar performance across several asset classes, but two fixed-income experts see several reasons to expect increased investor appeal for global bonds.
“Firstly, there are signs that inflation pressures are easing, led by US disinflation,” said Paul Grainger, head of Global Fixed Income & Currency at Schroders, and James Bilson, fixed income strategist, in a recent commentary
The two noted how over the past 18 months, goods inflation has served as a leading signal of rising inflation. Now that inflation is beginning to trend downward, they say a "bullwhip" effect is becoming more evident.
“Though we believe that the path to target inflation of 2% may ultimately prove difficult due to stickier services inflation, the relatively rapid initial improvements we expect to see in the first half of 2023 should be greeted very warmly by markets,” Grainger and Bilson said.
A more favourable backdrop for global bonds will result, they argued, including lower bond volatility and opportunities in certain categories of emerging-market fixed income.
Tighter financial conditions will be another tailwind. They noted how more trailing indicators, such as consumer expenditure and particularly the labour sector, continue to be quite resilient despite dramatically deteriorating leading indicators, such as housing.
“Our expectation is that over the coming months we will see clearer signs of the tightening of financial conditions impacting growth, especially in the US,” they said.
As central banks pause their tightening and re-evaluate the situation, they said it will be a boon for global sovereign bonds. The effect on cyclical assets like corporate bonds, however, will be mixed as the supportive forces of inflation and bond volatility collide with the weaker economy’s impact on companies’ earnings.
A third supportive factor for bonds, they said, is an impending end to central banks’ rate-hiking cycles. This is particularly true for the economies with particular sensitivity to higher interest rates.
“[W]e remain concerned that the speed and scale of global tightening will have ramifications in those economies where household debt and house price to income ratios are high,” Grainger and Bilson said.
They said the reduced ability for certain central banks to tighten policy – including those in the most vulnerable economies like Sweden, Canada, and the U.K. – potentially creates opportunities to be relatively long on bonds they issue compared to those from less exposed regions like the U.S. and Europe.
Finally, they noted that bond values are appealing, with yields significantly higher than they were a year ago.
“Once market participants begin to put less weight on inflation … and engage with the deteriorating growth backdrop, there will be very good return potential realised across global fixed income markets,” they said.
