Is fixed income back in fashion? Commentary by Richard Flax
Richard Flax, CIO Moneyfarm
After almost two years of interest rate increases, in 2024 the combination of high coupons and easing of monetary tightening could finally create favorable conditions for fixed income. After the lows of 2022, in fact, bonds have not yet recorded the long-awaited rebound, indeed during 2023 the continuous upward pressure on rates (unexpected for many) led this asset class to underperform, with the exception of a few positive results which we witnessed in the fourth quarter, thanks to the rebalancing of the monetary structure.
Even in 2024, at least so far, the challenge remains open: if, on the one hand, analysts are inclined to believe that rates have now reached their peak, on the other, the pace and extent of the cuts are still an unknown and, in the In recent weeks, fears relating to inflation and economic stability have weakened the prospects of a sudden drop in rates. What is certain is that higher initial returns contribute to a renewed importance of the bond component within a diversified investment strategy.
Should we expect a “new era” for bonds?
Over the long term, fixed income has the potential to produce higher returns than it has over the past decade. This is because equilibrium interest rates should remain more or less in line with nominal GDP growth, which, according to the latest estimates from the World Economic Outlook, is destined to remain high over the next five years.
In the short term, however, the performance of bonds is closely linked to the trend in rates, which continue to be expected to decline in 2024, despite the fact that optimism about the extent of the cuts has weakened significantly over the last few weeks. The easing of monetary policy should bring greater stability to the bond market, but, more than the forecasts, the consequences of the central banks' moves will matter when tested by the facts. A restrictive turn compared to expectations could lead to a partial increase in rates, with consequences especially for long-term bonds, while short-term bonds (within two years) should be less affected. For this reason, the short-term part of the curve remains the most interestingwith the current level of rates still offering a good risk-return profile, while longer-term bonds, fresh from the excellent performance of November and December, with the inversion of the yield curve (which tends to remunerate less long-term lenders) appear to carry additional risks.
In conclusion, although current returns appear interesting, bond investing is not without risks: the fact that long-term expected returns are high represents excellent news for those who invest with a diversified strategy and a long time horizon, but , on average, the longer part of the curve does not promise additional returns compared to the less risky short-term part, at least for the main developed markets. The dynamics of fixed income is peculiar: although the absolute yields are the highest in recent times, the spread compared to less risky government bonds is not particularly high when compared with historical values. We therefore believe that, rather than a “new era”, the current interest rate levels represent a positive “new normality”, finally capable of compensating for the risk borne by investors.
*Chief Investment Officer of Moneyfarm
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