What are the risks and opportunities for fixed income in 2024?
- The renewed supply-driven rise in oil price shows that the risk of inflation rising once more is currently the biggest risk to markets so investors shouldn’t discount higher-for-longer rates.
- There are still potential opportunities in both investment grade and high yield, particularly in short-duration strategies. Investors are also increasingly using active ETFs to “fill the gaps” in standard indices and generate alpha.
- We are seeing Environment, Social and Governance considerations playing an increasingly important role in investors’ portfolios.
What is our current market outlook?
Last year was a very tough 12 months for fixed income markets globally. Equity markets are used to a high level of volatility but to see returns of -10% in fixed income and credit is quite unusual. Since then, market volatility has eased but remains elevated due to uncertainty around central bank decisions.
On the other hand, we are not certain inflation volatility has eased: while we anticipate inflation will decrease in the future, the unpredictability of oil and energy prices could bring unexpected setbacks. This is the main market risk that can influence central bank decisions. On recession, our base case scenario is that momentum is decelerating but we are not entering a tough or deep recession.
How does this currently impact credit markets?
Credit now offers an attractive return of nearly 5% for a duration of below 5 years1 , which has not been the case for over the last decade in the euro market. In the past, some companies issued bonds at 0%, now on average we have coupons at around 4% in investment grade segment and 6-7% in high yield1 .
When looking at the investment grade space, we are looking for companies with good EBITDA, good visibility on cash flow generation, satisfactory leverage and liquidity. These are factors that we see today. On the technical front, there is a lot of demand given these attractive yields and we expect this may continue for the next 12 months.
Are there any opportunities in high yield?
High yield looks quite different to investment grade. High yield has performed extremely well in 2023 because of the macro background which has behaved better than expected at the beginning of the year.
Unfortunately, flows have not been the main driver of performance, rather it was the lack of supply which supported the asset class. Clients are starting to question the impact of higher default rates and the impact of growth on those companies that are smaller and have less room to manoeuvre. Even though default rates have risen, they remain under historical averages, but we anticipate further increases.
In this environment, we continue to see opportunities in short duration high yield strategies as well as strong demand for fixed maturity products.