The fourth quarter ended on a strong note, with most risk assets rallyingsignificantly into year-end and fixed income spreads at or near their tightest levelsof the year. Risk assets gave back some of these gains and yields moved a little bithigher to start January, but credit spreads remain on the tight end of anticipatedvaluation ranges. The fundamental backdrop remains constructive despite the tightvaluations.
Expectations that the Federal Reserve will cut rates are helping drive investoroptimism, with markets pricing in five to six cuts in 2024. The Fed strengthened its“pivot” language at its December meeting, with Chair Powell’s press conferenceincorporating more reminders of its dual mandate. The Fed’s assessment thatinflation is moderating, subject only to a couple more months of confirmation, marksa shift in the conditions under which rate cuts may occur. If the Fed is correct in itsassessment that “sticky” core inflation has come unstuck, this opens the door for amore constructive 2024, with the possibility of a strong US economy alongside ratecuts. However, the market is pricing in twice the number of rate cuts than the Fed’sforward guidance indicates, and while we do expect rate cuts this year, we believethey will be fewer and start later than the market anticipates.
While the probability of a US recession has subsided, the picture outside the US hascontinued to weaken. Contrary to the more dovish language coming out the Fed,the European Central Bank (ECB) maintained its commitment to data dependenceand did not demonstrate a similar readiness to contemplate rate cuts. This stancepersisted even as inflation declined more rapidly than anticipated and growth dataindicated weakness. In China, weakness in the property sector continues to worryinvestors, and the fundamental picture now looks weaker, with a rebound expectedto come later than originally thought. In addition, risks are emanating from theshipping disruptions in the Red Sea and the ongoing conflicts between Russiaand Ukraine as well as Israel and Hamas. Their potential for regional spillover andunforeseen fall-on effects adds considerable uncertainty to the global outlook.
Into this backdrop, we expect fixed income assets to generate decent total returnsduring the year, driven primarily by carry. We expect to see heightened periods ofvolatility given the various geopolitical risks and potential for disappointing inflationprints, but ultimately, we think the trend will be for range-bound rates and marginallytighter spreads. Given the expectation that central banks will ease policy, we believenew investors will come into the market, helping provide a backstop against anysevere spread widening. As a result, we continue to act as buyers into short-termperiods of weakness.
Our Asset Class Outlooks
Investment Grade Credit
Fundamentals remain strong, with only a modest increase indefaults expected in 2024. Looking at technicals, we expectstrong domestic demand to continue and interest from foreignbuyers to increase, given signals of easier policy from the Fed,while all-in yields remain near historical highs. Net supply isexpected to be lower compared to 2023, which should also besupportive. Current market conditions point to a continuation ofrecent supportive trends, and we maintain our positive outlookfor US dollar investment-grade credit in the near term.Within non-US-dollar credit, we remain cautiously positivein the medium term and still prefer the euro over the sterlingcredit markets.
Securitized Products
Over the long term, we are bullish. Mortgage-backed securities(MBS) have tightened dramatically, but there is room to tightenfurther on a relative value basis versus investment grade (IG)credit. The Fed minutes and recent Fed speakers have indicatedthat the pace of QT is now under discussion. A slowing of Fedasset sales would be a boost for MBS.
Leveraged Finance
Markets are currently priced for a soft landing, but with tolerabledownside scenarios. The resilient macro outlook supports ourexpectation for a modest increase (but not a major spike) indefaults. The fundamental strength in credit metrics appears tohave peaked but started at a strong level. 2024 public earningsestimates indicate that the first quarter will be the earningstrough, with moderate sequential growth from there. Tighterspreads leave assets fairly valued at the bottom of our 350-550bp trading range. We expect spreads to remain range-bound.
Emerging Markets
Despite the recent tightening, we are more comfortable withemerging market (EM) corporate IG spreads considering the lagin 2023 against developed markets (DM) and sovereigns, alongwith the solid fundamental picture. We also expect the supply-sidetechnical backdrop to remain strong. Meanwhile, hardcurrency sovereign spreads remain tight. Corporates continue tooffer a better risk/reward proposition.
Non-US-Dollar Currency
Perceived monetary policy divergence between the Fed and theECB has acted as a dampener on the US dollar in recent months.Given market positioning against the dollar, a countertrend maydevelop in favor of the currency. We believe the US dollar waspunished too hard in December and should strengthen fromthese levels.
Segment Snapshots
Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the global fixed income market.
Investment Grade Credit
US Dollar Investment Grade Credit
Dana Burns, Portfolio Manager, US Dollar Investment Grade Fixed Income
FundamentalsFundamentals remain firm despite an uptick in interest costsdue to improved cash balances as management teams reducedcapex and share buybacks.
ValuationsCredit spreads are at the tighter end of the range. Nevertheless,appetite for primary issuance and the long end remainssupportive given attractive all-in yields. “Story names” havestarted to catch up with the larger, more liquid credits.Intermediate financials remain attractive.
TechnicalsDemand for US IG credit remains strong, with lower supply anda lack of bonds available for sale continuing to support the longend. Reduced concern over higher interest rates has lent supportto intermediate and longer-dated corporates.
Non-US-Dollar Investment Grade Credit
Roberto Coronado, Portfolio Manager, Non-US Dollar InvestmentGrade Credit
FundamentalsCompanies in general continue to post decent results whilebalance sheets remain healthy and M&A activity remains low.Management teams, however, are providing cautious outlooks,citing limited visibility into future sales and margins as theeconomic outlook remains uncertain.
ValuationsWe view credit spreads as close to fair value and expect theindex to trade within a range in the coming weeks and months.We see a low probability of large index moves in either direction.For that reason, sector and security selection will be the key tooutperformance, in our view.
TechnicalsFlows into euro corporates have been strong over the pastseveral weeks, while supply has been slightly below the highexpectations for January. Investors continue to be better buyersof credit.
Securitized Products
Andrew Budres, Portfolio Manager, Securitized Products
FundamentalsThe fundamentals of the MBS market continue to be strong.Most of the market is less negatively convex than historicallevels and interest rate volatility (implied vol) has dropped sinceOctober.
ValuationsEven after the extraordinary performance of MBS over the pasttwo months, it still has room to tighten versus IG credit and ifimplied interest rate vol continues to drop.
TechnicalsNow that banks are past the SVB crisis and rate hikes and areclearly not in peril, they can focus once again on growing theirbalance sheets, which will likely mean adding MBS.
Leveraged Finance
John Yovanovic, CFA, Head of High Yield Portfolio Management
FundamentalsThe macro outlook continues to be resilient enough to supportour expectations for a modest increase (but no spike) indefaults. Last-12-month par-weighted default rates now standat 2.8%/2.1% (with and without distressed exchanges), with nonew activity in December. This is an increase from 1.7%/0.9%in 2022. The par-weighted upgrade/downgrade ratio was 0.9 inNovember, versus 1.3 for the full year. (Fundamentals data basedon JP Morgan data as of 2 January 2024.)
ValuationsThe par-weighted upgrade/downgrade ratio was 0.9 inNovember, versus 1.3 for the full year. With a large portion ofthe loan market trading at or near par, we should see furtherrepricing activity, which will continue to pressure nominalspreads. (Based on Morningstar LCD data as of31 December 2023.)
TechnicalsWith the continued rally in rates through the end of the year, newissuance continued at a decent clip in December with $13.3billion gross ($2.4 billion net). Full-year issuance came in at$175.9 billion gross ($59.5 billion net), up from $106.5 billion in2022 but still well below historical levels. Fund flows were +$2.7billion for the month, nearly all ETFs. Demand for loans from newCLO formation remains, while retail funds should see furtheroutflows, although at a more moderate pace than last year.(Technicals based on JP Morgan Securities data as of 2 January2024.)
Emerging Markets
Sovereigns
Ilke Pienaar, Head of Sovereign Research,Emerging Markets Fixed Income
FundamentalsFundamentals remain on an improving trend, driven by bothstructural and cyclical factors. Growth outperformed in 2023 versusexpectations at the start of the year and is expected to hold up in2024 despite a drop in DM growth and a slowdown in global growth.This highlights changing global trade trends, including near-shoringand EM-to-EM trading. Debt-to-GDP ratios will fall in the majorityof countries – but a few heavyweights will cause the EM averageto move sideways. A number of countries are near the end ofrestructuring their debt, which will also reset the macro outlook.
ValuationsDespite widening again after the year-end rally, spreads are stilltight. At 399, the EMBI is at a level last seen in April 2022 and isbeing kept wider than long-term averages by only a few credits.HY spreads are narrower by 119 bps from the end-October 2023peak and about 15 bps wider than our fair value estimates. IGcontinues to trade through our fair value calculations, but onlymarginally so (roughly 5 bps). (Spread data from Bloomberg as of15 January 2024.)
TechnicalsRecord issuance to date this year paints a constructive picturefor the rest of 2024. Gross issuance in 2024 should be similarto 2023, but the amortizations and coupon payments shouldbe larger, causing net financing to swing into negative territory.Hard currency inflows at the end of 2023 were short-lived, andoutflows have resumed in early 2024 at a pace similar to 2023.Local currency flows have been positive for the last four weeks.
Corporates
Kim Keong, Trader, Emerging Markets Fixed Income
FundamentalsJ.P. Morgan recently published a report showing net negativecorporate credit ratings for 2023 but nonetheless the bestlevels since 2018. Upgrade volumes increased, mainly drivenby sovereign upgrades in the Middle East and Brazil, anddowngrade volumes were the lowest since 2019.
ValuationsOver the last month, the CEMBI BD spread to worst tightenedby 8 bps, with HY (-23 bps) outperforming IG (-5 bps). Betaperformed better, and in terms of region, LatAm performedbetter in IG and CEEMEA outperformed the rest in HY. Argentina,Nigeria, Macau, Turkey, and Chile were the main outperformers,while South Africa, Colombia, Saudi Arabia, and Taiwan were themain underperformers. In comparison to DM during the sameperiod, EM corporate IG outperformed US IG by 3 bps but lagged23 bps in 2023, and EM corporate HY tightened against US HY by26 bps in the past month but lagged 100 bps in 2023. We believethe current pickup offers value in EM corporate IG, especially inthe A and BBB buckets. (Valuations data from Bloomberg basedon the CEMBI Broad Diversified index as of 16 January 2024.)
TechnicalsGross supply in 2023 concluded at $245 billion, while netfinancing was at -$157 billion. January is typically an activemonth for primary markets, with an average issuance of $56billion in recent years. So far this month, we’ve seen $19.2 billionin gross issuance. We anticipate $33 billion in scheduled cashflow for the month, which could result in a positive monthly netsupply. Syndicate desks are optimistic about primary activitythis year compared to 2023. However, with the theme of localissuance persisting, we still expect a positive supply-sidetechnical in 2024. (Valuations and Technicals from JP MorganEM Corporate Weekly Monitor as of 8 January 2024).
Non-US-Dollar Currency
Dmitri Savin, Portfolio Manager, Portfolio and Risk Strategist,Emerging Markets Fixed Income
FundamentalsWhile US disinflation (as measured by the six-month averagecore PCE) has been faster in the last six months than previouslyenvisaged, enabling Chair Powell to sound surprising dovishin the December meeting, US labor market conditions remaintight. With US unemployment below 4%, ultimately the Fed’sscope should be limited for moving into emergency mode andstarting its rate-cutting cycle in March. Instead, our base caseis one where the Fed considers real yields too high and startsnormalizing monetary policy halfway through the year.
ValuationsWe are keeping our 12-month euro/US dollar forecast at 1.0500,in line with our “Stabilization” scenario. We have kept our12-month US dollar/Japanese yen forecast at 1.4250 to reflectcountervailing forces between the current yield differential andscope for the Bank of Japan to exit negative interest rate policy.
TechnicalsAccording to IMM data as of 10 January, US dollar positioningis now net short at -0.7 sigma below the five-year average, wellbelow the +0.5 sigma peak in November.
About This Report
Fixed Income Asset Allocation Insights is a monthly publication that brings together the cross-sector fixed income views of PineBridge Investments. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the fixed income universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the global fixed income market.
Disclosure
Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
