Summary
Time to refocus on bonds
Inflation has risen to levels not seen in 40 years, leading to a repricing of financial markets this year, which has been particularly severe in the fixed income space. Central Banks have already started to hike rates and turn to the hawkish side to avoid de-anchoring inflation expectations. The era of low or even negative interest rates is over. We strongly believe that this new market context provides a new paradigm for bonds, with more attractive valuations and a renewed outlook.
- Valuations: fixed income valuations are now as attractive as equities’ from a relative standpoint, as a result of higher inflation figures coupled with CB actions.
- Outlook: although we expect more volatility in the coming weeks, as investors process central bank actions and communications, and weigh up the trade-offs between the risk of higher inflation and slower growth, interest rates are not going back into negative territory.
On top of this new environment, we see 3 main factors supporting the renewed interest for bonds:
- Higher yields: current levels have become attractive; being invested in fixed income is paying off once more.
- More diversification: negative correlation between bonds and equities may return in a more uncertain economic environment, making bonds more appealing as a portfolio diversifier.
- A macro hedge in the case of increased risk of Eurozone fragmentation or political uncertainty, bonds could provide some portfolio protection. This would also be the case if aggressive tightening by the Fed prompts a recession (and the Fed has shown its commitment to do whatever it takes to fight inflation).
At this point, we think that the asset class is becoming attractive again and offers interesting entry points. It makes sense to allocate to bonds within a diversified portfolio allocation, but selection remains important, favouring market segments – such as core government bonds – with a flexible approach, while looking for quality in the credit space.
Back to bonds: a journey through the regime shift
With inflation becoming a dominant feature of the regime and Central Banks starting to act, we see three phases for bond markets: the great repricing (that played out in H1), stabilisation and normalisation. We currently stand at the beginning of the second phase, where some curve repricing is already done, Central Banks have become more hawkish to fight inflation and the growth picture has deteriorated. In this context, bond yields are stabilising and could again be seen as a source of diversification and protection against recession fears.
4 reasons to look at bonds
Four main themes for investors
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