“Bond markets are more attractive to investors now than they have been for years, in some cases decades,” argues Raymond Sagayam, CIO Fixed Income at Pictet Asset Management.
The shakeout of the past year has lifted yields across the fixed income universe to levels where investors have significant margins of safety. Even in the face of sticky inflation and further rises in yields, investors could still manage to generate positive returns.
To be sure, “caution is warranted in light of geopolitical and macroeconomic upheaval,” Sagayam warns. For instance, “while in some respects inflation appears to be moderating, it’s unlikely to fall as fast as central bankers expected a year ago. Which is why it’s premature to draw the conclusion that the war against inflation has been won. The risk is that central banks now maintain rates higher for longer.”
“Investors should perhaps ease back into fixed income rather than plunging head first. And they need to be selective.”
For now, short-dated bonds look most attractive almost across the board, given inverted yield and credit curves and very attractive breakeven yields. As it becomes clear that developed market central banks are reaching the end of their tightening cycles, potentially in 2023, longer dated sovereign debt will start looking more attractive – whether rates plateau or start to come down quickly.
Emerging market debt already looks interesting from a tactical point of view. Indeed, emerging market economies are in much healthier positions than they were in previous cycles, and emerging market central banks have been further ahead of the inflationary curve, offering meaningfully higher real rates than their developed market counterparts. In addition, emerging market currencies are deeply undervalued, especially against the dollar.
Corporate credit is likely to lag the other markets. Over the near term, companies will feel the squeeze as earnings and margins come under pressure from rising interest rates, inflation and slowing demand. That’s not to mention the flood of paper that’s due to be refinanced in the coming years. Spreads are already rising in anticipation of increasing default rates – though the former will roll over before the latter peak.
“It’s still early days, but bond markets are more attractive to investors now than they have been for years, in some cases decades,” Sagayam argues. “Volatility and the risks of widespread and stagflation spreading is still a hazard to all risky assets amidst a still tenuous geopolitical backdrop. But there are now compensations for the risks investors face – especially in the bonds markets.”