Changes in market regime are rare and significant events.
The pandemic may have receded, but the impacts of its radical challenge to conventional fiscal and monetary policies will be with us for years to come.
We now know that 2020 brought the curtain down on a fixed income bull market that persisted for almost four decades.
At the same time, powerful inflationary forces were unlocked across many developed economies – forces that were accelerated by Russia’s invasion of Ukraine last year.
At several points during the past decade, we worried that our debates about the end of the era of low interest rates were merely academic.
But the moment we realised that the intellectual and political approach to fiscal policy had been changed by Covid-19 was the moment we appreciated the power of the forces at play – and their significance for yields and interest rates.
Last year was characterised by rapidly rising rates across the western world, monetary withdrawal and a severe repricing of both equities and bonds. There was nowhere for investors to hide: for much of the year, moving from equities to bonds meant moving from the frying pan into the fire.
This challenging correlation between price moves and what were perceived as safer assets took investors by surprise and defied conventional wisdom. Investment managers have been forced into a wholesale rethink of the role fixed income assets can play in their portfolios.
Today, with yields in our view attractive, we believe bonds are decisively back.
The key question then becomes: where do we believe the opportunities lie?
Prepping for recession
If, as seems likely, rates go high enough to drive up unemployment, we will eventually find ourselves in recession, and recessions typically mean difficulties for risk assets.
The longer economic resilience in the US can be maintained, the more the US Federal Reserve is likely to remain hawkish, and the more pressure there will be on yields to drift higher.
If and when a recession transpires, we believe it is possible to continue to thrive through strategic, active management of credit risk and exposure to duration and interest rates, positioning for opportunities as they arise.
Before this happens, in our view it is wise to take advantage of rising yields. In our view most major fixed income markets are attractive at present. We would anticipate that credit spreads could rally further when it becomes clear that interest rate hikes have crested.
We saw a preview of this during the market rally after benign inflation readouts in December; the investors wise (or lucky) enough to correctly call rates’ peak stood to benefit greatly.
Underlying all this is the growing importance of fundamental credit analysis.
