Market Views: Top bond strategies in play as rate cuts loom
Central banks, notably the US Federal Reserve, are expected to lower interest rates from their current elevated levels in the second half of this year, which will inevitably affect fixed income markets.
Asset owners will need to reassess their tactical and strategic allocations to the asset class.
For Asia-Pacific investors, evaluating currency hedging strategies will also be important, as shifting rates could impact relative currency valuations, determining the attractiveness of various fixed income approaches.
With rate cuts on the horizon, asset managers shared their perspectives on how investors can best position their fixed-income portfolios for the the latter half of the year.
The following responses have been edited for brevity and clarity.
Vanessa Chan, head of Asian fixed income investment directing
Fidelity International
With encouraging inflation figures in the US, we expect at least one cut from the Fed this year. Investors could seek potential returns from duration whilst looking for income generation opportunities from a diversified portfolio.
US credit has been surprisingly resilient thus far. We believe US Treasury bonds with preference for the 5–7-year part of the curve could offer good value.
In addition, the long-duration approach with tactical long in countries that embarked on the rate cut cycle could be considered.
As US market volatilities are expected to pick up as we get closer to the election, Asian investors may consider global income strategies beyond the US dollar bond market.
Other central banks such as the European Central Bank and the Bank of Canada embarked on their rate-cut cycle, which was followed by a repricing of cuts in favour of a more gradual pace.
The opportunities in European markets provide additional diversification benefits.
European credit spreads have widened on the back of recent election-related volatility whilst demand remains strong; with real yields at the highest levels in around 20 years. This is a good opportunity to generate real returns whilst adding diversifications to global income strategies.
Salman Niaz, head of global fixed income, Asia Pacific ex-Japan
Goldman Sachs Asset Management
In the second half of the year, investors can secure income and generate total returns by leveraging central bank easing cycles and navigating market volatility to their benefit.
Disinflation is back on track in the US and beyond, following early-year disruptions. Although growth is slowing, it remains positive, and the private sector's financial health is sound as reflected in key credit metrics.
The new environment of elevated yields creates opportunities in global corporate credit, both investment grade and high yield, alongside core fixed income and Asia credit.
However, the combination of tight valuations and political uncertainty leaves a narrow margin for error, underscoring the importance of active security selection, diversification, and dynamic sector and duration allocations.
Additionally, we recommend strategies to enhance portfolio resilience against policy-related uncertainties.
These could include leveraging the defensive role of perceived safe-haven currencies, and employing currency options that benefit from increased currency volatility.
It's also prudent to adopt a long-term view, acknowledging the expanding depth and diversity in the green bond market.
This includes emerging markets, which presents options for investors to incorporate a 'green' element into their fixed income allocations or to establish a dedicated green bond portfolio.
Siddharth Dahiya, head of emerging market corporate debt
abrdn
We are constructive on emerging market (EM) local currency bonds and EM corporate credit. Many central banks in EM, particularly those in Latin America, were quick to respond to rising levels of inflation by tightening financial conditions.
As a result, real rates are now in positive territory across EM and could cut rates to boost economic growth.
As the Fed embarks on its rate-cutting cycle, at the margin this could result in some US dollar weakness which following a decade-long bull run would be supportive for EM currencies.
We also think that corporate fundamentals across EMs remain in good shape with low net leverage levels – across investment grade and high-yield in comparison to developed markets counterparts. Technicals are also supportive as the level of bond repayments exceeds the amount of primary market issuance, meaning negative net financing.
Spreads have tightened in EM corporates over the past six months, as they have for bonds more generally but at an index level, yields remain close to 7%. We believe this remains an attractive point for investors in what is historically the most defensive part of the EM asset class.
Jenny Zeng, CIO of fixed income in Asia Pacific
Allianz Global Investors
After strong outperformance in the first half of the year, Asian fixed income is expected to continue to deliver resilient and compelling performance in the remainder of 2024.
This is underpinned by a stable macroeconomic and political backdrop, improving yield differentials against the US and eurozone, a favourable credit cycle, and robust technical support.
In Asian credit, we remain constructive on the total return potential of Asian high yield, thanks to the improving credit cycle, declining default rate, decent relative value vs other credit markets and strong technical factors.
The best carry opportunities are anticipated to come from sectors and companies in the sweet spot of the credit cycle, such as Indian infrastructure, Chinese utilities, Macau gaming and selective financial capital structure securities.
The credit trajectory remains stable to positive, default rates are low and total yield is reasonable.
On Asian rates, carry is also the main theme, given that the Fed is not rushing to ease monetary policy.
We are constructive on higher-yielding bond markets where inflationary pressures are contained, such as Indian government bonds and Indonesian government bonds.
We are also constructive on three-year Korea treasury bonds due to underpriced rate cut odds.
Naomi Fink, chief global strategist
Nikko Asset Management
One current market peculiarity is that some assets that provided good diversification against risk assets are not demonstrating the inverse correlations with stocks that they tended to show during the very recent regime of low inflation and interest rates. These include US and European bonds.
Given the concentration of stock returns in the US tech sector, the market needs good risk diversifiers more than ever.
Chinese bonds, in this context, provide a very good opportunity for diversification – economic growth is slow, but uncorrelated to the US cycle. Slow growth is typically no deterrent for bond performance.
Meanwhile, even as China engages in fiscal expansion – to counter the domestic slowdown – a very small proportion of Chinese bonds are owned by foreign investors, who are consequently under-allocated to Chinese or RMB-denominated assets.
Moreover, it is extremely unlikely, thanks to China’s current account surpluses, that there will be either internal or external default in China, giving Chinese bonds characteristics emblematic of uncorrelated “risk-free assets” typically appropriate to hedge against risk asset allocations.
Christopher Dillon, fixed income investment specialist
T. Rowe Price
We expect a 25 basis points rate cut from the Fed in September while acknowledging a growing probability that more Fed action may follow before year end.
Today’s world is less globalised and arguably more inflationary than the one left in late 2019. And with pandemic-related distortions finally working their way out of the financial system, global fragmentation concerns now arguably become more important.
We are focused on portions of the market that offer convexity, such as select securitised credit, which can participate in market upside while importantly limiting the downside of higher rates -- a risk that is largely being ignored by the market at this time.
With the Fed now poised to move, short-duration strategies take on heightened importance while emerging market debt looks to benefit from a less strong US dollar that looks to weaken near term with Fed action coming.
Robert Tipp, chief investment strategist and head of global bonds
PGIM Fixed Income
Our basic premise is that we are in an unusual bull market – one not driven by a quick drop in yields, but rather by earning yields at their newly, elevated levels.
Asian markets may be marginally disadvantaged relative to Western markets in some cases due to the strong dollar, but mostly because of capital saturation, which biases Asian yields lower and spreads narrower.
We favour a global relative value-based approach, within the context of an overall favourable fixed income backdrop.
Despite expected rate cuts, long rates may remain range-bound around current levels because of ongoing heavy government bond issuance. A range-bound market may seem like an uninteresting opening volley for a bullish thesis for bonds.
However, over the long term, yield is almost destiny in fixed income – and yields, in the context of the last 20 years, are high, boding well for future returns.
From an asset allocation perspective, bonds benefit from the last few years’ shift in valuations: From the current yield/price earnings configuration, bonds have historically delivered favourable risk-adjusted returns relative to equities.
Additionally, in an environment where central banks are on hold or cutting rates, bonds have typically performed as a shock absorber, delivering positive returns in quarters when stocks suffer steep declines.