- Global Investment and Multi-Asset Strategist
Explore our insights
contact us
Wellington Management Hong Kong Ltd
17/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong
+852-2846-6000
Hong Kong (香港), Individual
Change
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed.
Fixed income investors have experienced a “once-in-a-career” market correction: an 11% decline in the Bloomberg Barclays US Aggregate Bond Index (the “Agg”) through the first eight months of 2022, in combination with an 18% US equity market sell-off. In the current inflationary environment, fixed income has clearly not played its traditional protective role.
Rising interest rates, triggered largely by higher and “stickier” inflation than expected, and a scramble by the US Federal Reserve (Fed) to rein in inflation before a vicious cycle of surging wages and even higher prices takes hold, have been the drivers of the rout. What now? Ultimately, inflation will determine the path of rates going forward. However, here are three considerations that could support a contrarian view in favor of fixed income:
1. How much monetary policy tightening is already priced in? A lot. As Figure 1 illustrates, according to futures markets, many investors anticipate that the fed funds rate will reach 4.6% by mid-2023, some 200 basis points (bps) higher than its current range of 3.00% – 3.25%.
2. Is the economy responding to higher interest rates? To a degree. A bellwether index of US financial conditions has already dropped in response to this year’s spike in rates. The housing sector has cooled, supply-chain pressures have begun to ease, and the strong US dollar is disinflationary. Wages and shelter costs have continued to rise, though.
3. What will it take for the Fed to step back from tightening? Weaker demand and lower inflation. Fed Chair Jerome Powell has said it would likely take several months of lower core inflation for the Fed to consider retreating from hiking rates. A pattern of rising unemployment and below-trend growth might cause the Fed to pause on rate hikes.
What could go wrong from here?
The Fed is in uncharted territory, given the gap between current inflation (over 8%) and the Fed’s 2% target. Moreover, the Fed’s use of quantitative tightening to pare back its balance sheet, simultaneously with outright rate hikes, is untested. While the Fed is hoping its rate hikes will bring down inflation with only “some pain to households and businesses,” a deeper recession is a possibility. On the other hand, if the Fed pulls back and the market doesn’t believe inflation is under control, the Fed’s credibility would be at risk. In that scenario, inflation expectations could become “de-anchored,” pushing the 10-year US Treasury yield higher still.
Figure 1
Investment implications
- Don’t abandon fixed income at these levels. In an environment where the Fed is trying to crush inflation, even at the expense of below-trend growth, I think 10-year US Treasuries sporting around a 3.5% – 4.0% yield represent decent value for investors and should provide some portfolio diversification if the economy slows, especially given the longer-term structural impediments to growth.
- Consider diversifying fixed income exposure. Given the uncertain inflation outlook, committing too much capital to long-duration US fixed income may be risky. Diversifying across global bond markets and currencies with flexibility to tweak portfolio duration as needed may be a better strategy. High-quality corporate bonds look relatively attractive as of this writing, as do short-term bond yields at today’s levels.
- Quality is key for equities. Defensive sectors and dividend payers look likely to outperform the market amid elevated volatility as the Fed removes liquidity in the months ahead. Longer term, many investors are finding opportunities in high-quality companies with solid balance sheets and growing revenues and profits at potentially attractive entry points — including in less-favored sectors like technology and consumer discretionary.
Expert
Related insights
Showing
of
Insights Posts
URL References
Related Insights
Read next
Showing
of
Insights Posts
Tight money: Banks feeling the squeeze of higher rates
In this curated collection, some of our experts share their latest perspectives on the ongoing turmoil in the US banking sector and its potential implications.
Collection
2024-03-31
Understanding the US banking sector shake-up
Investment Communications Managers Jitu Naidu and Adam Norman detail recent US bank failures and analyze the implications. (Published 14 March 2023)
Quick Take
2024-03-31
SVB collapse: What are the implications?
Multi-Asset Strategist Supriya Menon shares her latest perspectives on the collapse of Silicon Valley Bank Financial Group (SVB) and the unfolding implications for investors. (Published 14 March 2023)
Quick Take
2024-03-31
On to the next crisis: Glimpsing a post-SVB world
Amid the turmoil in the US banking sector, Global Investment Strategist Nanette Abuhoff Jacobson suggests investors consider pivoting to a “risk-management mode” that favors higher-quality assets. (Published 14 March 2023)
Quick Take
2024-03-31
Deep and diverse: Welcome to today’s Asia credit market
Two of our Singapore-based experts on Asia credit discuss the market's key features, along with how it's evolved and is likely to continue doing so.
Whitepaper
2024-03-31
Three themes that could define 2023 for income investors
With several macro crosscurrents at play, Portfolio Manager Peter Wilke suggests that income-oriented investors not lose sight of the “big picture” in their quest for yield.
Quick Take
2024-01-31
Will the Fed send the US economy into a recession?
Multi-Asset Strategist Adam Berger and US Macro Strategist Juhi Dhawan consider the broad impact of Fed rate hikes and how asset allocators should respond.
Continue reading
Article
2023-07-31
Credit investing against a slower-growth, higher-inflation backdrop
The significant flattening of the US Treasury yield curve in recent months has some prognosticators calling for an impending US recession. Not so fast, says Fixed Income Portfolio Manager Rob Burn.
Continue reading
Quick Take
2022-07-31
US inflation risk, angry bondholders, and silver linings
Here are quick thoughts on some common questions I’ve been asked recently about Fed policy, yields, the US dollar, and financial markets.
Continue reading
Quick Take
2023-05-31
Timely musings on Fed policy and inflation
With rising inflation and interest rates dominating the financial headlines in recent weeks, I have been fielding a flurry of colleague and client questions about the likely future trajectory of US monetary policy. While I don’t claim to have all the answers, especially with so many “known unknowns” as of this writing, here are my latest thoughts.
Continue reading
Quick Take
2023-05-31
Global convertibles: Poised to benefit from five structural tailwinds
Fixed Income Portfolio Manager Michael Barry and Investment Specialist Raina Dunkelberger believe global convertible bonds are likely to outperform other fixed income sectors over an investment time horizon of approximately two to three years. Learn why.
Continue reading
Quick Take
2023-04-21
URL References
Related Insights
DISCLOSURE
This material and its contents may not be reproduced or distributed, in whole or in part, without the express written consent of Wellington Management. This document is intended for information purposes only. It is not an offer or a solicitation by anyone, to subscribe for shares in Wellington Management Funds (Luxembourg) III SICAV (the Fund). Nothing in this document should be interpreted as advice, nor is it a recommendation to buy or sell shares. Investment in the Fund may not be suitable for all investors. Any views expressed are those of the author at the time of writing and are subject to change without notice. Investors should carefully read the Key Facts Statement (KFS), Prospectus, and Hong Kong Covering Document for the Fund and the sub-fund(s) for details, including risk factors, before making an investment decision. Other relevant documents are the annual report (and semi-annual report).
Issued by Wellington Management Hong Kong Limited. Investment involves risk. Past performance is not indicative of future performance. This document has not been reviewed by the Securities and Futures Commission of Hong Kong.
