The time when high yield bonds will perform best

The time when high yield bonds will perform best

If economies soon reach the peak of the interest rate raising cycle, then it will be high yield, rather than government bonds which outperform, according to Stephane Monier, chief investment officer at Lombard Odier.

The rate of interest at which central banks decide the peak has been reached is known as the terminal rate of interest. 

Monier said: “2023 may divide into two distinct phases. The effects of tighter monetary policy, high inflation and slowing growth will carry into 2023, demanding prudent portfolio positioning. However, once real interest rates peak, the economic cycle will pivot, creating opportunities to raise allocations to risk assets.

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"That will only happen once the Federal Reserve halts its interest rate hikes. The central bank is entering a new phase in its monetary cycle by slowing the pace of tightening as inflation declines slowly from four-decade highs. A higher peak in interest rates will accompany a probable recession late in 2022 and into 2023. The resilience of the American job market will be key to the shifting pace of monetary policy.”

He said he expected the terminal interest rate to be reached in Europe and the US in 2023.

Monier added: “As investor sentiment improves, appetite for risk assets will increase. Once high yield credit spreads more fully price a recession, and rates have stabilised, the carry in this segment will be more attractive than investment grade, and sovereign bonds.”