‘Once in a generation’ opportunity to access fixed income

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
‘Once in a generation’ opportunity to access fixed income
AP Photo/Richard Drew

The recent rally in global markets does not reflect the reality of the changes central banks will be making to interest rates in the coming months, Jupiter’s fixed income team has said.

Markets, particularly those in the US, have bounced in the past month despite poor economic forecasts predicting high inflation and a potential recession beginning this winter.

Market participants were optimistic that deteriorating economic data would prompt central bank policymakers to ease their interest rate tightening plans, Jupiter said, triggering a classic “short squeeze” in a bear market.

Indeed, data from Bank of America released earlier this month showed fund managers’ fears of an economic slowdown were easing.

However, Jupiter’s fixed income team does not think those views are correct.

“We’d argue that equity moves don’t reflect reality,” Jupiter said. 

This could well lead to an extended period of secular stagnationJupiter

Firstly, it is unlikely that the Fed will pause its rate hikes, the fund house said.

“While forward looking indicators are pointing to slower growth, Fed policy is essentially determined by backward looking indicators on inflation and jobs…inflation may have peaked but is still way too high for the Fed to feel comfortable yet that it’s going back to target.”

US inflation eased slightly in the 12 months to July this year, dropping to 8.5 per cent from 9.1 per cent a month earlier.

Secondly, Jupiter said, investors haven’t yet got to grips with the extent of the recession ahead.

“So far this year consumers have drawn down savings and added debt to fund consumption, and headroom is running out.”

Another reason is another underpriced slowdown, this time in China.

“The unwinding of the China real estate bubble will take years to play out, zero-Covid is still stymieing growth, consumer confidence is low, and a sharp slowdown in durable goods spending in developed economies will hit Chinese manufacturing,” Jupiter said.

“This could well lead to an extended period of secular stagnation.”

This is therefore a once in a generation opportunity to access fixed income marketsJupiter

Against this backdrop, many investors have “allowed themselves” to hope the Fed will relent, Jupiter said, but the central bank is likely to continue to tighten, deepening the slowdown.

The longer central banks pursue the taming of inflation at the expense of all else, the deeper and more damaging the growth fallout.

This will ensure the snap back in yields is “particularly violent” when the pivot arrives.

Jupiter’s fixed income team says it is positive on longer duration bonds, especially in the US, as well as Australia and South Korea. 

“In the short term therefore, we remain cautiously positioned…the bond markets in our view better reflect reality, anticipating Fed hikes at the short end, and falling growth with lower rates farther out.”

It will be a bumpy ride as a recession looms, but eventually with inflation slowing, central banks will ease policy, Jupiter said.

“This will bring with it a return to “lower for longer”, which is a strong backdrop for fixed income investors as yields fall, credit markets are backstopped, and duration diversifies risk assets again. 

“This is therefore a once in a generation opportunity to access fixed income markets – but caution is advised in credit markets, you need to know what you own can make it through a recession.”

sally.hickey@ft.com