- Fixed Income Portfolio Manager
Singapore, 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.
An inverted US Treasury yield curve is often viewed as a reliable recession indicator, so the significant flattening of the curve over the past few months — and in an environment of persistent inflationary pressures, to boot — has some economic prognosticators calling for an impending US recession. I say not so fast.
While I acknowledge that the economic outlook will likely deteriorate at the margin as monetary policy tightens, particularly if energy prices remain elevated, I do not believe the recent flattening of the yield curve portends a US recession in the near term. US consumer balance sheets look very healthy, household savings rates are robust, and rising worker wages may help cushion against the impact of higher goods and energy prices. Furthermore, the US should remain relatively shielded from today’s uncertain geopolitical landscape, given its lower oil imports from Russia and its greater domestic oil production compared to Europe.
What’s driving recent yield curve flattening?
The recent flattening (and inversion) between the two-year and 10-year parts of the yield curve has been primarily driven by the increase in short-term yields following the more aggressive policy tightening stance adopted by the US Federal Reserve (Fed) in response to stubborn inflationary pressures. Yet the three-month and 10-year “shape” of the curve — historically a more reliable recession indicator — still has a ways to go before inverting, given that the Fed has only just begun to hike the fed funds rate (Figure 1).
Figure 1
Central bank-induced recession not imminent
The Fed intends to tighten financial conditions in an effort to alleviate the effects of higher inflation, but it will likely be mindful of the attendant risks to the economic cycle. Specifically, I expect the Fed to remain keenly cognizant of the danger of tightening policy too aggressively against a backdrop of heightened geopolitical tensions. This type of measured approach should further contribute to the “stickiness” of inflation and could raise the odds of a stagflationary outcome (i.e., high inflation in tandem with slowing growth).
That being said, I think a lot would need to go wrong in order for US economic growth to contract in the period ahead. All else being equal, it would likely take one to two years of steady Fed interest-rate hikes for tighter monetary policy to tip the US economy into recession. Projections by the Fed and futures markets have the policy rate increasing to 2.8% and 2.6%, respectively, by the end of 2023 — only slightly above the neutral rate and not overly restrictive, in my view.
Some sectors may benefit from higher inflation
While inflation can indeed erode the returns provided by traditional high-grade, rate-sensitive fixed income assets, I believe a number of bond sectors can prove resilient and even be net beneficiaries of higher inflation, including persistently elevated energy prices.
Obvious choices for sectors that can potentially benefit from inflation include bank loans (given the floating-rate nature of their coupons, which reset higher as interest rates rise) and Treasury Inflation-Protected Securities, aka TIPS (since their coupons are directly indexed to, and thus protected from, inflation). I also expect high-yield corporates, convertible bonds, securitized credit, and emerging markets (EM) local debt to outperform most traditional high-grade fixed income sectors in a rising-rate/high-inflation environment, particularly if the global economic expansion continues throughout 2022 and beyond. Some points to consider:
- Floating-rate bank loans, high-yield corporates, and convertible bonds have actually exhibited flat to negative empirical durations over time, meaning these credit sectors have historically generated positive total returns during periods of rising US Treasury yields.
- Within structured finance, non-agency residential mortgage-backed securities (RMBS) stand out, where solid fundamentals remain intact and the collateral typically benefits from rising home prices, which I expect to persist amid scant supply.
- For similar reasons, inflation also tends to favor commercial real estate, although not all property types are created equal. We currently see the best opportunities in single-asset, single-borrower deals.
- EM debt remains vulnerable to geopolitical flare-ups, but many local markets are under-owned by foreign investors. EM central banks are well ahead of the Fed in hiking rates to help blunt inflation, while high commodity prices are a boon to some EM commodity exporters.
Bottom line: Be opportunistic in the credit markets
While my outlook for the US credit cycle has worsened somewhat on the back of tighter financial conditions and significant inflationary pressures, I still do not believe a central bank-induced recession is around the corner. I am seeing plenty of investment opportunities in today’s environment in spite of — in fact, because of — the high levels of economic uncertainty and market volatility that have characterized 2022 so far.
Expert
Related insights
Showing
of
Insights Posts
URL References
Related Insights
Read next
Showing
of
Insights Posts
Chart in Focus: Compelling opportunities in four higher-yielding credit sectors
Portfolio Managers Campe Goodman and Rob Burn share insights on where they are seeing compelling opportunities in high-yielding credit sectors.
Quick Take
2025-03-11
Three ways to elevate your portfolio in 2024
As a new investment era takes shape, where should investors focus their attention in 2024? For multi-asset strategist Nick Samouilhan, three areas are top of mind: higher yields, the importance of stock selection and how to position for structural change.
Article
2026-01-31
Credit: Better opportunities to add risk on the horizon
ur experts review current macro dynamics impacting the bond market and discuss where they see opportunities and risks across credit sectors.
Article
2024-12-31
Chart in Focus: Cash vs. bond returns in rate hiking cycles
Global Investment and Multi-Asset Strategist Nanette Abuhoff Jacobson and Investment Strategy Analyst Patrick Wattiau explore the relative potential benefits of bonds versus cash.
Quick Take
2024-08-31
Why cash won’t cut it for long: The case for bonds
Global Investment and Multi-Asset Strategist Nanette Abuhoff Jacobson and Investment Strategy Analyst Patrick Wattiau explore the relative potential benefits of bonds versus cash.
Quick Take
2024-08-31
Credit market outlook: Expect greater opportunities in back half of 2023
Against a backdrop of elevated recession risks and banking-sector stress, Fixed Income Portfolio Manager Rob Burn identifies relative-value sector opportunities in the credit market.
Article
2024-06-30
Asia: A growth story with longer-term momentum
Is China’s recovery already running out of steam? Macro Strategist Santiago Millán assesses the outlook for China and Asia and sees longer-term momentum for growth.
Article
2024-06-30
Three macro assumptions that could be just plain wrong
Fixed Income Portfolio Manager Brij Khurana offers his non-consensus take on three entrenched, but potentially flawed, beliefs in today's market environment.
Quick Take
2024-04-30
Will higher rates sap US consumer spending?
Higher interest rates have increased borrowing costs. Could a consumer-led US recession be looming? Fixed Income Portfolio Manager Kyra Fecteau sees three factors that may help mitigate the impact.
Quick Take
2024-03-31
US recession risk: No longer if, but when and how bad
Portfolio Managers Brij Khurana, Brian Garvey, and Nick Petrucelli believe many observers are underestimating the severity of a potential US recession this year.
Quick Take
2024-01-31
URL References
Related Insights
Past results are not necessarily indicative of future results and an investment can lose value. Funds returns are shown net of fees. Source: Wellington Management
© 2023 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. The Overall Morningstar Rating for a fund is derived from a weighted average of the three, five, and ten year (if applicable) ratings, based on risk-adjusted return. Past performance is no guarantee of future results.
The content within this page is issued by Wellington Management Singapore Pte Ltd (UEN: 201415544E) (WMS). This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. Information contained on this website is provided for information purposes and does not constitute financial advice or recommendation in any security including but not limited to, share in the funds and is prepared without regard to the specific objectives, financial situation or needs of any particular person.
Investment in the funds described on this website carries a substantial degree of risk and places an investor’s capital at risk. The price and value of investments is not guaranteed. The value of the shares of the funds and the income accruing to them, if any, and may fall or rise. An investor may not get back the original amount invested and an investor may lose all of their investment. Investment in the funds described on this website is not suitable for all investors. Investors should read the prospectus and the Product Highlights Sheet of the respective fund and seek financial advice before deciding whether to purchase shares in any fund. Past performance or any economic trends or forecast, are not necessarily indicative of future performance. Some of the funds described on this website may use or invest in financial derivative instruments for portfolio management and hedging purposes. Investments in the funds are subject to investment risks, including the possible loss of the principal amount invested. None of the funds listed on this website guarantees distributions and distributions may fluctuate and may be paid out of capital. Past distributions are not necessarily indicative of future trends, which may be lower. Please note that payment of distributions out of capital effectively amounts to a return or withdrawal of the principal amount invested or of net capital gains attributable to that principal amount. Actual distribution of income, net capital gains and/or capital will be at the manager’s absolute discretion. Payments on dividends may result in a reduction of NAV per share of the funds. The preceding paragraph is only applicable if the fund intends to pay dividends/ distributions. Performance with preliminary charge (sales charge) is calculated on a NAV to NAV basis, net of 5% preliminary charge (initial sales charge). Unless stated otherwise data is as at previous month end.
Subscriptions may only be made on the basis of the latest prospectus and Product Highlights Sheet, and they can be obtained from WMS or fund distributors upon request.
This material may not be reproduced or distributed, in whole or in part, without the express written consent of Wellington Management.
