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20 April 2023

Four Reasons to Embrace Fixed-Income

By Robert O. Abad

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Fixed-Income Offers Compelling Return Potential

Shiller data going all the way back to 1870 confirms that 2022 was the worst calendar year for US Treasury (UST) total returns and only the second time that USTs posted back-to-back negative annual total returns. Will this trend extend into 2023?

No. We believe a third consecutive year of negative UST returns is highly unlikely. Our rationale is that in 2022 an unforeseen worldwide inflation shock combined with an aggressive and rapid response by central banks globally to make 2022 the worst year on record for the bond market. We don’t envision a repeat of this scenario given the magnitude of rate hikes already executed and increasing evidence of moderating global growth and inflation. This backdrop should support lower yields and healthier bond returns.

Exhibit 1: Nominal Annual Return on US Bonds
Explore Nominal Annual Return on US Bonds
Source: Robert Shiller, Bloomberg. As of 31 Dec 22. Select the image to expand the view.

Fixed-Income Offers Diversification Benefits

The classic 60/40 (stocks/bonds) portfolio completely failed to provide its historical diversification benefits as correlations all moved positively together in 2022. Do we expect this anomaly to persist?

No. Fixed-income’s diversifying properties are already reasserting themselves as fundamentals take center stage. The sharp decline in bond yields (notably at the front end of the yield curve) seen in March due to heightened concerns over US and European banking system stability is one indication that stock and bond market correlations are normalizing.

Exhibit 2: Long US Treasuries and Equities—Yearly Total Returns Since 1926
Explore Long US Treasuries and Equities—Yearly Total Returns Since 1926
Source: Ibbotson, Bloomberg. Equities represented by the S&P 500. Long US Treasuries represented by Bloomberg Long US Treasury Bonds. As of 31 Dec 22. Select the image to expand the view.

Fixed-Income Now Offers Less Volatility

In 2022, we witnessed a historic period of monetary tightening over a very short span of time which resulted in record-breaking episodes of bond price volatility. The Federal Reserve (Fed) alone hiked short-term rates by more than 400 bps in 2022, which is unprecedented in its speed. Do we expect central banks to continue on this path?

No. The market is now looking forward to global central banks pausing (or even cutting) given the backdrop of softening global growth and inflation. This should temper fixed-income volatility going forward.

Exhibit 3: Global Central Bank Actions
Explore Global Central Bank Actions
Source: Haver Analytics, Bank of International Settlements. As of 31 Dec 22. Select the image to expand the view.

Fixed-Income Now Offers Investors More Choice

With the combination of higher rates and wider spreads having restored the forward-looking prospects for fixed-income yields, what’s a fixed-income investor to do?

Get involved. We haven’t seen this level of all-in yields going back a decade, reinforcing the idea that the starting point for fixed-income—with an emphasis on credit—in 2023 appears very attractive.

Exhibit 4: Yield-to-Worst Across Fixed-Income Sectors (Past 10 Years)
Explore Yield-to-Worst Across Fixed-Income Sectors (Past 10 Years)
Source: Bloomberg, FactSet, J.P. Morgan Credit Research, J.P. Morgan Asset Management. Indices used are Bloomberg except for emerging market debt and leveraged loans: EMD (USD): J.P. Morgan EMIGLOBAL Diversified Index; EMD (LCL): J.P. Morgan GBI-EM Global Diversified Index; EM Corp.: J.P. Morgan CEMBI Broad Diversified; Leveraged loans: JPM Leveraged Loan Index; Euro IG: Bloomberg Euro Aggregate Corporate Index; Euro HY: Bloomberg Pan-European High Yield Index. Yield-to-worst is the lowest possible yield that can be received on a bond apart from the company defaulting. All sectors shown are yield-to-worst except for Municipals, which is based on the tax-equivalent yield-to-worst assuming a top-income tax bracket rate of 37% plus a Medicare tax rate of 3.8%. Guide to the Markets—US Data are as of 31 Mar 23. Select the image to expand the view.
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