Fixed Income Outlook 2024

Social Bonds : A significant financing opportunity amid the pandemic

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Introduction

The Fed softened its policy stance, and credit markets reacted enthusiastically in 4Q23. However, despite this fervor, fixed-income assets are as attractive as they are likely to be in the near future. Nevertheless, the high benchmark rates, translating to a slow economy and tight money supply, could result in higher default rates and liquidity issues.

Inflation: Declining; breakeven anchored at c. 2%

  • Headline inflation in the US and Europe is broadly trending downwards and expected to be anchored at c. 3% for the US and c. 4% for Europe in 2024, above the respective central bank’s target of 2%

  • Lower food and energy prices, healing in supply chains and easing price pressure on goods are likely to support the downward trend of inflation. Housing inflation will likely be a significant factor in overall price measures, as cost of owner-occupied houses may keep up price pressures through the rest of 2024

  • Meanwhile, Treasury Inflation-Protected Securities (TIPS) breakeven (across tenors) is anchored at c. 2%. This suggests that the US markets are expecting inflation to fall back to 2% within a few years

  • TIPS remain attractive. The 30-year TIPS yield is near 2% (vs -0.5% in 2020-21), traded below 2.3% for more than 50% of the time in 2023

Interest rates (US): A plausible higher-for-longer environment

  • Markets see a ‘soft landing’ as the base case for 2024: Growth is likely to be slow, and the labour market will likely weaken, but markets do not expect a recession that typically corresponds with significant declines in risk assets

  • Over-expectation of a >100bps rate cut has been cut: Jan-24 stronger-than-expected data yet again fuelled concerns of a ‘higher-forlonger’ rate. In Dec-23, markets were expecting six cuts by c. 1.35% in 2024 (beginning Mar-24), but, at present, traders anticipate 3 cuts by end-2024. Financial markets no longer see rate cuts starting in Mar-24 as possible; May-24 looks unlikely, and even Jun-24 seems less certain

  • Fixed income assets will likely benefit from a pause in monetary policy. The 10-year yield typically falls 100bps after a rate pause amid no/ mild recessions

  • The final hike of each Fed cycle has historically been a turning point for fixed income investors. The rule of thumb has been to buy/lengthen duration at a terminal hike and sell/shorten duration at a recession’s end to maximise the benefits (see chart on left-hand side – the yellow line highlights the final hike of each cycle). Inflation-adjusted yields across fixed income look quite attractive, especially across corporates and municipalities.

Views on fixed income asset classes

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