By Nick Hayes, Head of Total Return and Fixed Income Allocation at AXA IM
Historically these trends produce strong total returns for fixed income. However, with the existing geopolitical tensions and conflicts showing no signs of relief and more democratic elections scheduled in 2024 than ever, the risk of further volatility and shocks cannot be ruled out.
2023 though, was a year, where we experienced a number of bond positive and negative themes. Mixed economic data, persistent inflation and an elusive global recession after such monetary tightening meant volatile fixed income markets. Adding to this, deficit sustainability concerns with large issuance of government bonds and hawkish central banks caused a prolonged rates sell-off during Q2 and Q3.
On the positive side, it was a good year for credit; resilient global growth, balance sheet strength and more recently the market’s rejection of a hard landing has helped spreads grind tighter throughout the year. In addition, since late October, the sell-off in rates has now reversed and bonds have rallied aggressively as central banks move to a more dovish tone, with strong signals that the rate hiking has come to an end and expectations of rate cuts for 2024.
Here, we offer five reasons why we have high expectations for fixed income in 2024.
1. Falling government bond yields
Our conviction is that we are now entering the next phase of the economic cycle, characterised by weaker economic data, a pause in monetary tightening and eventual rate cuts. Historically this is a good time to own duration.
We expect the medium-term trend is for yields is to remain higher than we have seen for many years but trend downwards. In 2024 we believe investors will be paid well for taking fixed income risk through attractive yields.
2. Diminishing risk of higher rates
The likelihood of positive fixed income returns increases with the reduced risk of rate hikes. Across developed markets inflation is falling faster than expected and we are starting to see signs of loosening labour markets. In the UK and Europe there is little to no growth, and in the US the Federal Reserve has suggested it is unlikely to hike rates further.
Geopolitical and global supply chain shocks withstanding, the risk of higher central bank rates is diminishing as we enter 2024.
In this environment returns from cash-like low duration instruments is diminishing but the attractiveness of owning rate sensitive assets is high. Government bonds and credit could be the beneficiaries of this as investors with trillions of dollars in money market funds and cash face increasing re-investment risk 2024.
3. Cross-market and yield curve opportunities
We do not expect markets to be synchronised in 2024 and the extent and speed of which central banks necessitate rate cuts will vary. This means choosing where to take duration risk, as well as having an outright duration view will be a way in which investors can enhance their contribution from rates.
We expect the long-term steepening of yield curves to continue in 2024. However, markets do not move in straight lines and yield curves will change shape as different economic scenarios are priced in. In this environment there will be opportunities to tactically allocate across different maturities.
4. Higher dispersion
As we move into 2024 we expect the dispersion between higher and lower quality issuers to increase.
The lag effect of monetary policy passing through into the real economy and imminent maturity walls will punish issuers with weak balance sheets and with excessive leverage. However, those which borrowed long and have maintained strong balance sheets will, on the other hand, be rewarded. This presents an opportunity for fundamentally driven investors who have confidence in their single name credit selection. No longer is the difference in yield between a good issuer and a bad issuer negligible.
5. The power of diversification
Given the richness of the fixed income asset class, bonds offer an unparalleled source of diversification and multiple sources of return.
The negative medium-term correlation of rates and spread that returned to fixed income in 2023 we believe will continue into 2024 and beyond. Taking advantage of this negative correlation means investors can find different sources of fixed income performance in different market environments. A diversified risk exposure across fixed income risk factors helps create attractive, fixed income risk adjusted returns across a full market cycle.
The risk-return balance for fixed income is the best it has been for a generation and fixed income assets rightly deserve a place in investor’s portfolio in 2024.
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