Is fixed income back to playing defence?

I would think about surprises relative to what's in the price of the market today, and that's how we spend a lot of time thinking about these things. Currently priced into the market has been the resurgence of a soft landing and that's become more consensus versus being out of consensus. So I think risk to either side of that pricing would create volatility in what's already priced in markets today. So that would be the risk of further downside to growth and that restrictive rates have gone too far too fast and we start feeling in a much more urgent sense the implications of that to the economy. I think that the probability of that is relatively low over the next 12 months.

The transmission mechanism for these policy hikes in places like the US is a little bit more slow to take effect in the structure of the economy. So we have a little bit more time. And to the upside on growth, that we haven't done enough, I equally see that's not priced in the markets. But the base case, I think, still would be where we're centred on stable-ish growth, albeit some slowing growth, but not extremes either positive or negative to the growth outcome as we stand today.

Has fixed income regained its defensive mantle?

I think we're re-entering that territory now. I think it's been hard psychologically for many investors when they reflect on their asset account statement of last year and they see a big negative number on their bond portfolio. It's been a while and a reminder of what can happen in environment like we had. 

But the upside to this is we have created value in fixed income again, and there is the defensive role that bonds can play are back there, and that's a function of coupons being higher in the market, as well as coupons helping buffer the interim price volatility you can have in bonds. 

We didn't have that before, now we have high income. And I think also a belief that inflation, provided you think it's going down towards longer-term targets that central banks have and they've done their job, inflation that's not unruly can also help restore the correlation structures you would expect between bonds and equities and other asset classes. So simple answer would be yes, I think bonds can start playing that role again.

Where are you seeing the best value in fixed income markets?

I think, full stop, a lot of value in fixed income today, as a function of the disastrous year of 2022 and in the revaluation of the asset class in higher yields. For investors, it's really a question of, what are you trying to solve for with different parts of the bond market? 

There is a very strong rationale to be made for high-quality fixed income being a larger allocation and rebuilding ballast. So things like government bonds, things like agency mortgages that are passed through and risk-free, even high-grade or investment-grade corporate credit fills a role. 

But that's not to say that there's not a role for riskier parts of fixed income.

So if you're looking at things like the high yield bond market or the leverage loan market, the bank loan market, yields there are very high and many investors are starting to say, "Well maybe these are comparable to equity or share returns." Maybe they're competing now with the return profile you historically would associate with shares. So I guess there's something for everybody in fixed income today. It's a question of what you're trying to solve for.

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