Executive Summary
- In the US, the recent murkiness in the economic currents likely puts a Fed turn out further than we had previously expected.
- In Europe, our view is that inflation will fall sharply in coming months and that the ECB will stop short of raising rates beyond what is currently discounted by markets.
- In the UK, forward-looking indicators suggest a meaningful slowing of inflation and lackluster economic activity, which should slow further as past monetary tightening gains its full traction.
- In China, growth is on track for the 5% target this year with government officials intent on stabilizing growth and market sentiment.
In line with our expectations, global growth is downshifting and the disinflation process is clearly underway, albeit unevenly. Lessening bottleneck pressures, financial stability concerns contributing to tighter credit conditions in the US and Europe and softer manufacturing and services demand worldwide are helping to alleviate price pressures globally. These trends, combined with the major central banks continuing to advocate for restrictive monetary policy for an extended period, should further temper growth and inflation. In such a scenario, we expect developed market (DM) government bond yields to trend lower and that the US dollar will weaken modestly. These factors should act as a tailwind for emerging markets (EM), where central banks are closer to the end of the tightening cycle relative to the developed world, and valuations are attractive. Spread sectors such as high-yield, bank loans and select areas of the mortgage-backed securities (MBS) space also offer attractive yield but we acknowledge that credit markets remain vulnerable to unanticipated shifts in macro-related sentiment, geopolitical developments and the risk of central bank overtightening. Here, we provide a summary of the key drivers behind our global outlook and describe where we see value across global fixed-income markets.
| US: Economic Crosscurrents Emerging |
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The effects of Federal Reserve (Fed) tightening on the US economy are accumulating, but these have not proceeded as fast as market expectations had banked on, and there are some crosscurrents emerging as well. On the demand side, business capital spending continues to decline mildly, and businesses have continued to cut back on inventories. Also, US exports have been generally declining since the fall of 2022. Consumer spending on goods continues to trend mildly lower, but at no faster a pace than we have seen generally over the past two years. Consumer services spending is slowing as well, but this has camouflaged somewhat the continued growth in health care spending, as consumers pursue treatments and procedures that were likely postponed during the pandemic.
The crosscurrents are a recent bounce in vehicle production and a stabilization in home sales and housing starts. Thanks to a semiconductor chips shortage, the post-pandemic recovery in motor vehicles lagged behind the rest of the economy. With that shortage now alleviated, carmakers are catching up on postponed production. Vehicle demand is only at pre-Covid levels, but inventories are substantially depleted, thanks to the preceding chips shortage. Vehicle production will provide a major boost to 2Q23 GDP growth, but we would expect production to flatten out thereafter. Similarly, we think claims of a housing shortage are misreading the signals from the new-home market, and that housing starts and residential construction are due to head downward again, especially for multifamily units.
We think resolution of these industry issues and continued deceleration elsewhere will eventually lead the Fed to a very long-term cessation of tightening and a turn to easing. However, the recent murkiness in the economic currents likely puts that Fed turn farther in the future than we had previously expected. |
| Europe: Downside Growth Risks Persist |
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Overall, we see the risks to European growth as being tilted to the downside as we move through the second half of this year. Germany is already experiencing a mild technical recession and credit conditions are tightening across the region, particularly in the periphery. Most forward-looking survey indicators are consistent with ongoing weakness in both manufacturing and service sectors. However, the labor market remains quite tight, which is supporting consumption, particularly in the services sector, and although elevated energy and food prices remain meaningful headwinds for consumers and businesses, they have started to abate from recent highs.
In June, the European Central Bank (ECB) raised rates again by 25 basis points (bps), to 3.50% as widely expected. Furthermore, ECB President Christine Lagarde highlighted that a July hike is “very likely” and reiterated that the ECB was “not thinking about pausing.” Taken together, inflation in May and June surprised to the downside by 0.3%, but still remains above the ECB’s comfort zone despite several forward-looking indicators pointing to a continued moderation in price pressures. Although June headline and core inflation both printed in line with expectations, they emphasized the disparity between eurozone economies and the corresponding challenges for the ECB; Spanish headline CPI inflation grew 1.6% year-over-year (YoY) in June, compared to 6.8% in Germany. Given that the impact of the significant policy-tightening to date has yet to be felt, along with our view that inflation will fall sharply in coming months, we believe that the ECB will stop short of raising rates beyond what is currently discounted by markets, which should provide support for European bond markets.
Consumer price inflation in the UK is slowing, helped by strong base effects due to lower energy prices. This will continue through the year, although the passthrough is somewhat slower than in the euro area due to the way that regulated price caps for households are set quarterly. Inflation has not fallen as fast as expected so far, however, as services inflation has remained stubbornly high. We view this as a dichotomy between higher-income households, with accumulated savings and low sensitivity to higher interest rates such that their spending power is maintained (resulting in persistent upward pressure for the price of flights, package holidays, hotels and recreation), and a growing majority of households, which are being squeezed by the higher cost of essentials, negative real income growth and an increased sensitivity to higher interest rates as debt servicing, mortgage repayments and rents become more costly. Given the Bank of England’s (BoE) data-dependent stance, the Bank Rate was raised by 0.50% most recently, to 5.00%. Furthermore, the market-implied peak Bank Rate has been lifted above 6.00%. We feel that this is excessive given that forward-looking indicators suggest a meaningful slowing of inflation and lackluster economic activity, which should slow further as past monetary tightening gains its full traction. |
| China: Supported and Targeted Growth |
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China’s growth is on track for a 5% target this year, with more volatile, noisy monthly data due to the lack of persistent and strong growth drivers. We see moderate growth and a lack of inflation keeping Chinese interest rates at current low levels for longer. At a June 16 meeting, the State Council made it clear that it would step up macro policy support to expand domestic demand, strengthen and optimize the real economy, and prevent/ resolve risks in key areas. After meeting on June 29, the State Council announced that it would introduce a new home appliance stimulus, with details to be released later. Various “micro” policy-easing measures will likely be introduced from now until late July, when respective policy details are finalized. However, the focus will be on stabilizing growth and market sentiment. |
|
US: Economic Crosscurrents Emerging
 |
We think claims of a housing shortage are misreading the signals from the new-home market.
The effects of Federal Reserve (Fed) tightening on the US economy are accumulating, but these have not proceeded as fast as market expectations had banked on, and there are some crosscurrents emerging as well. On the demand side, business capital spending continues to decline mildly, and businesses have continued to cut back on inventories. Also, US exports have been generally declining since the fall of 2022. Consumer spending on goods continues to trend mildly lower, but at no faster a pace than we have seen generally over the past two years. Consumer services spending is slowing as well, but this has camouflaged somewhat the continued growth in health care spending, as consumers pursue treatments and procedures that were likely postponed during the pandemic.
The crosscurrents are a recent bounce in vehicle production and a stabilization in home sales and housing starts. Thanks to a semiconductor chips shortage, the post-pandemic recovery in motor vehicles lagged behind the rest of the economy. With that shortage now alleviated, carmakers are catching up on postponed production. Vehicle demand is only at pre-Covid levels, but inventories are substantially depleted, thanks to the preceding chips shortage. Vehicle production will provide a major boost to 2Q23 GDP growth, but we would expect production to flatten out thereafter. Similarly, we think claims of a housing shortage are misreading the signals from the new-home market, and that housing starts and residential construction are due to head downward again, especially for multifamily units.
We think resolution of these industry issues and continued deceleration elsewhere will eventually lead the Fed to a very long-term cessation of tightening and a turn to easing. However, the recent murkiness in the economic currents likely puts that Fed turn farther in the future than we had previously expected. |
|
Europe: Downside Growth Risks Persist
 |
Overall, we see the risks to European growth as being tilted to the downside as we move through the second half of this year. Germany is already experiencing a mild technical recession and credit conditions are tightening across the region, particularly in the periphery. Most forward-looking survey indicators are consistent with ongoing weakness in both manufacturing and service sectors. However, the labor market remains quite tight, which is supporting consumption, particularly in the services sector, and although elevated energy and food prices remain meaningful headwinds for consumers and businesses, they have started to abate from recent highs.
In June, the European Central Bank (ECB) raised rates again by 25 basis points (bps), to 3.50% as widely expected. Furthermore, ECB President Christine Lagarde highlighted that a July hike is “very likely” and reiterated that the ECB was “not thinking about pausing.” Taken together, inflation in May and June surprised to the downside by 0.3%, but still remains above the ECB’s comfort zone despite several forward-looking indicators pointing to a continued moderation in price pressures. Although June headline and core inflation both printed in line with expectations, they emphasized the disparity between eurozone economies and the corresponding challenges for the ECB; Spanish headline CPI inflation grew 1.6% year-over-year (YoY) in June, compared to 6.8% in Germany. Given that the impact of the significant policy-tightening to date has yet to be felt, along with our view that inflation will fall sharply in coming months, we believe that the ECB will stop short of raising rates beyond what is currently discounted by markets, which should provide support for European bond markets.
Consumer price inflation in the UK is slowing, helped by strong base effects due to lower energy prices. This will continue through the year, although the passthrough is somewhat slower than in the euro area due to the way that regulated price caps for households are set quarterly. Inflation has not fallen as fast as expected so far, however, as services inflation has remained stubbornly high. We view this as a dichotomy between higher-income households, with accumulated savings and low sensitivity to higher interest rates such that their spending power is maintained (resulting in persistent upward pressure for the price of flights, package holidays, hotels and recreation), and a growing majority of households, which are being squeezed by the higher cost of essentials, negative real income growth and an increased sensitivity to higher interest rates as debt servicing, mortgage repayments and rents become more costly. Given the Bank of England’s (BoE) data-dependent stance, the Bank Rate was raised by 0.50% most recently, to 5.00%. Furthermore, the market-implied peak Bank Rate has been lifted above 6.00%. We feel that this is excessive given that forward-looking indicators suggest a meaningful slowing of inflation and lackluster economic activity, which should slow further as past monetary tightening gains its full traction. |
|
China: Supported and Targeted Growth
 |
We see moderate growth and a lack of inflation keeping Chinese interest rates at current low levels for longer.
China’s growth is on track for a 5% target this year, with more volatile, noisy monthly data due to the lack of persistent and strong growth drivers. We see moderate growth and a lack of inflation keeping Chinese interest rates at current low levels for longer. At a June 16 meeting, the State Council made it clear that it would step up macro policy support to expand domestic demand, strengthen and optimize the real economy, and prevent/ resolve risks in key areas. After meeting on June 29, the State Council announced that it would introduce a new home appliance stimulus, with details to be released later. Various “micro” policy-easing measures will likely be introduced from now until late July, when respective policy details are finalized. However, the focus will be on stabilizing growth and market sentiment. |
Global Market Rates: Relative Value by Region
| US | US growth is decelerating, and corporate earnings look to be declining, albeit from relatively high levels. There also still looks to be a downtrend in inflation. The question is whether these slowing trends are proceeding fast enough to mollify the Fed. This is looking less likely lately. |
| Canada | The BoC resumed its rate-hiking cycle, though we think the market now is extrapolating too much from here. While the Canadian economy did not prove as sensitive to higher rates as expected, in particular to residential mortgage rates, lagged impacts are still in the pipeline. Core inflation, while well off of 2022 highs, has been trending down over the past year. |
| Europe | We believe the ECB will be able to stop tightening policy over the coming months when it sees evidence of inflation slowing meaningfully in H2 as suggested by forwarded-looking indicators. Economic activity should remain weak as previous tightening gains traction and more signs of labor market weakness emerge. |
| UK | Additional hikes by the BoE will require evidence of more persistent inflationary pressures. Forward-looking indicators suggest that inflation will slow materially. Economic activity should remain lackluster at best as previous tightening gains traction and the labor market loosens further. |
| China | We expect 2023 growth to come in between 4.5% and 5.5%, with policymakers focused on economic recovery. We do not expect broadbased growth stimulus; rather, we expect continued, targeted measures. |
| Japan | Given stronger than expected growth and inflation, the BoJ remains open to making the necessary adjustments to maintain its yield curve control (YCC) framework. |
| Australia | Growth is expected to slow throughout the second half of 2023 as the RBA remains committed to bringing inflation back to target. The runway for a soft landing has shortened as the RBA continues to hike; however, a technical recession likely would only be mild if it occurs at all, due to a solid fiscal position, the immigration bounce-back and the country’s current strong export position. |
Relative Value by Sector
| Investment-Grade (IG) Corporate Credit |
| US |
| Outlook Corporate fundamentals have peaked but remain resilient. Margins are pressured but top-line revenue growth continues in the low single-digit range. Corporate managements also continue to behave conservatively given uncertainty with the macro backdrop. The current banking system stress, while complex, should not be systemic and volatility there should eventually abate. |
| Relative Value +/- Spreads are currently just fair and do not offer much cushion against tail risks and macro uncertainty. We continue to maintain overweights to banking, energy, select reopening industries and rising-star candidates, where allowed. |
| Europe |
| Outlook Earnings have so far proved resilient and outlooks are cautiously positive. Leverage remains stable with certain cyclical sectors running lower leverage than in the past. Bank balance sheets are strong in Europe, with a high level of regulatory oversight. |
| Relative Value + After a firm 2Q23, spreads look reasonably attractive on a historical basis, particularly for shorter maturities. |
| Australia |
| Outlook Fundamentals remain sound despite the prospect of the economy slowing. We remain focused on issuers that can manage inflation pressures and are defensive in nature. Fortunately, due to the monopolistic or duopolistic nature of many issuers in Australia, they naturally have these characteristics and many of the regulated assets are protected by resets. |
| Relative Value + We remain overweight credit, particularly shortdated holdings with a preference for select REITs and utility and infrastructure assets that have regulated resets. We also favor senior unsecured major bank and foreign national champion bank issuance. |
| High-Yield (HY) Corporate Credit |
| US |
| Outlook HY credit spreads are relatively attractive. Default rates are likely to rise from very low levels in the coming quarters, but current yields are providing ample cushion for higher defaults, which are likely to be below historical averages given the higher credit quality of the market on average. Technicals have been marginally negative over the last year given passive outflows, but higher yields are beginning to attract new institutional buyers. |
| Relative Value + We continue to see opportunity in service-related sectors that are still recovering from the Covid-led recession (i.e., reopening trades including airlines, cruise lines and lodging) and potential rising stars. We are more cautious on companies with closer ties to housing-related activity and therefore lack pricing power. |
| Europe |
| Outlook Concerns over the European growth outlook persist. Corporates are facing fewer headwinds than feared, but there is some evidence of margin squeeze. Issuance is picking up as 2024/2025 maturities need to be refinanced. |
| Relative Value +/- Valuations have become more attractive with yields around 8%, but spreads at around 470 bps are back to 1Q23 levels, leaving the market vulnerable to more volatility. Our focus is on BB and B rated credits and short-dated yield to call opportunities. |
| Bank Loans |
| US |
| Outlook Bank loan spreads are relatively attractive. While fundamentals are expected to decline from robust levels as growth slows, current yields are providing ample cushion for gradually higher defaults. Valuations have improved meaningfully, and technicals may soon improve as demand for discounted floating- rate loans from CLOs may exceed moderate new-issue supply. |
| Relative Value + We believe outperformance will come from credit selection and avoiding problem credits. We are focused on select names where fundamentals remain intact and prices are at discounts to their call price. |
| Collateralized Loan Obligations (CLOs) |
| US |
| Outlook Any improvement in the CLO arbitrage or reduction of broader macro volatility is likely to be met with CLO issuance, keeping spreads relatively rangebound in the near term. Hedging costs for overseas investors have risen over the last few quarters, but high-quality CLOs still screen attractive for overseas investors, which should lead to demand. |
| Relative Value + We view AAA rated CLO debt at current levels as very attractive and retain our view that it will continue to perform well in either bullish or bearish bank-loan-spread environments given strong structural protections. |
| Mortgage and Consumer Credit |
| Agency MBS |
| Outlook Agency MBS presently offer solid fundamentals with current spreads at attractive levels and prepayment risk structurally low. Diminishing Fed and bank demand coupled with increased volatility remain headwinds but present investment opportunities. |
| Relative Value + We favor 30- and 20-year versus 15-year MBS, focusing on security selection to enhance yield and convexity profiles. |
| Non-Agency Residential MBS (NARMBS) |
| Outlook Persistently high mortgage rates in conjunction with limited new and existing housing supply continues to put downward pressure on housing affordability in the US. While real estate is presented with various challenges due to broad economic uncertainty, we do not see a significant risk of defaults in the broad residential market. |
| Relative Value + We are opportunistic on credit risk transfer (CRT) securities as well as non-QM deals that present attractive borrower profiles and higher credit qualities. |
| Non-Agency Commercial MBS (CMBS) |
| Outlook Negative office sentiment has pervaded the market, leading to broad-based risk-off approaches by many participants. Underlying fundamental performance remains generally benign, with limited distress outside of the office sector. Worst-case scenarios are priced in to most subsectors. |
| Relative Value +/- Both new-issue conduit and secondary single asset/ single borrower (SASB) present compelling opportunities to lend on high-quality collateral with acquisition or cash-in financing. |
| Asset-Backed Securities (ABS) |
| Outlook We are cautious on consumer fundamentals and watchful of credit deterioration on lower-credit consumers. We prefer higher-quality consumer sectors, established sponsors and sectors with positive tailwinds. |
| Relative Value + We are focusing on senior AAA bonds across higher credit quality consumer sectors and on-the-run commercial ABS sectors. |
| Inflation-Linked |
| US |
| Outlook US TIPS real yields are attractive at levels above prior cycle highs, and breakeven inflation (BEI) levels are close to Fed targets throughout the curve. Although we expect disinflation trends to continue, TIPS now represent good value outright and, in most risk scenarios, relative to USTs. |
| Relative Value + Longer-dated BEI are a good value versus nominal USTs in our base case, but could be attractive as a diversifier within US bond portfolios. |
| Europe |
| Outlook ECB tightening is beginning to gain traction via lending channels and lower headline and core inflation. Goods demand prospects look soft going forward and production tailwinds have lessened as backlogs have been filled. Services, a strong point, have begun to slow. Core inflation will weaken further in 3Q23 and headline will fall sharply in 4Q23. |
| Relative Value - The market is currently pricing a terminal policy rate closer to 4.0% in September. 30-year breakevens are pricing 2.75% versus a 30-year average of around 1.75%. We remain underweight inflation at this tenor both versus the US and in outright terms. |
| Japan |
| Outlook Inflation-linked JGBs remain undervalued as the current 10-year BEI is well below 2%. Inflation is expected to continue to rise, but then moderate in the second half of 2023. However, underlying inflationary pressures are proving stronger than initially expected, as suggested by a more sustained rise in core inflation than expected. |
| Relative Value + We maintain an overweight to Japanese real yields against nominal yields. |
| Municipals |
| US |
| Outlook Municipals continue to offer attractive value for investors subject to tax rates, as tax-exempt yield levels remain near decade highs. Despite the potential for an economic slowdown, traditional state and local revenues remain near record levels which should support credit conditions. |
| Relative Value + We continue to favor longer duration securities and also prefer lower-rated IG securities that can benefit from the resilient credit profile of state and local municipal securities. |
| Emerging Market (EM) Debt |
| EM Sovereigns (USD) |
| Outlook Positive developments in global inflation and resilient US growth have incrementally improved the outlook for EM assets. We continue to view global central bank policy, commodity prices and geopolitics as key macro drivers of EM returns. |
| Relative Value + We believe HY frontier sovereigns represent the best 2023 total return opportunity in EM given wide valuations and improving support from global investors. |
| EM Local Currency |
| Outlook EM central banks’ proactive tightening measures over the past two years have set up a more positive outlook for both rates and FX in 2023. We expect certain Latin American central banks to start cutting rates in 2H23 even in the absence of cuts by the Fed. |
| Relative Value + While FX will remain highly macro-driven, signs of the peaking of both EM price pressures and policy rates provide the opportunity to add exposure to EM local rates. |
| EM Corporates |
| Outlook EM corporates continue to maintain strong balance sheets, but we are watching the liquidity of domestic-focused issuers given higher local rates and tightened global financial conditions. |
| Relative Value +/- Given comparatively tight valuations relative to DM corporates, we are focused on EM primary issuance at a concession to secondary. EM corporates’ lower duration and volatility may be ideal for clients looking for a more conservative allocation to EM. |
| Sector | Outlook | Relative Value | |
| Investment-Grade (IG) Corporate Credit | |||
| US | Corporate fundamentals have peaked but remain resilient. Margins are pressured but top-line revenue growth continues in the low single-digit range. Corporate managements also continue to behave conservatively given uncertainty with the macro backdrop. The current banking system stress, while complex, should not be systemic and volatility there should eventually abate. | +/- | Spreads are currently just fair and do not offer much cushion against tail risks and macro uncertainty. We continue to maintain overweights to banking, energy, select reopening industries and rising-star candidates, where allowed. |
| Europe | Earnings have so far proved resilient and outlooks are cautiously positive. Leverage remains stable with certain cyclical sectors running lower leverage than in the past. Bank balance sheets are strong in Europe, with a high level of regulatory oversight. | + | After a firm 2Q23, spreads look reasonably attractive on a historical basis, particularly for shorter maturities. |
| Australia | Fundamentals remain sound despite the prospect of the economy slowing. We remain focused on issuers that can manage inflation pressures and are defensive in nature. Fortunately, due to the monopolistic or duopolistic nature of many issuers in Australia, they naturally have these characteristics and many of the regulated assets are protected by resets. | + | We remain overweight credit, particularly shortdated holdings with a preference for select REITs and utility and infrastructure assets that have regulated resets. We also favor senior unsecured major bank and foreign national champion bank issuance. |
| High-Yield (HY) Corporate Credit | |||
| US | HY credit spreads are relatively attractive. Default rates are likely to rise from very low levels in the coming quarters, but current yields are providing ample cushion for higher defaults, which are likely to be below historical averages given the higher credit quality of the market on average. Technicals have been marginally negative over the last year given passive outflows, but higher yields are beginning to attract new institutional buyers. | + | We continue to see opportunity in service-related sectors that are still recovering from the Covid-led recession (i.e., reopening trades including airlines, cruise lines and lodging) and potential rising stars. We are more cautious on companies with closer ties to housing-related activity and therefore lack pricing power. |
| Europe | Concerns over the European growth outlook persist. Corporates are facing fewer headwinds than feared, but there is some evidence of margin squeeze. Issuance is picking up as 2024/2025 maturities need to be refinanced. | +/- | Valuations have become more attractive with yields around 8%, but spreads at around 470 bps are back to 1Q23 levels, leaving the market vulnerable to more volatility. Our focus is on BB and B rated credits and short-dated yield to call opportunities. |
| Bank Loans | |||
| US | Bank loan spreads are relatively attractive. While fundamentals are expected to decline from robust levels as growth slows, current yields are providing ample cushion for gradually higher defaults. Valuations have improved meaningfully, and technicals may soon improve as demand for discounted floating- rate loans from CLOs may exceed moderate new-issue supply. | + | We believe outperformance will come from credit selection and avoiding problem credits. We are focused on select names where fundamentals remain intact and prices are at discounts to their call price. |
| Collateralized Loan Obligations (CLOs) | |||
| US | Any improvement in the CLO arbitrage or reduction of broader macro volatility is likely to be met with CLO issuance, keeping spreads relatively rangebound in the near term. Hedging costs for overseas investors have risen over the last few quarters, but high-quality CLOs still screen attractive for overseas investors, which should lead to demand. | + | We view AAA rated CLO debt at current levels as very attractive and retain our view that it will continue to perform well in either bullish or bearish bank-loan-spread environments given strong structural protections. |
| Mortgage and Consumer Credit | |||
| Agency MBS | Agency MBS presently offer solid fundamentals with current spreads at attractive levels and prepayment risk structurally low. Diminishing Fed and bank demand coupled with increased volatility remain headwinds but present investment opportunities. | + | We favor 30- and 20-year versus 15-year MBS, focusing on security selection to enhance yield and convexity profiles. |
| Non-Agency Residential MBS (NARMBS) | Persistently high mortgage rates in conjunction with limited new and existing housing supply continues to put downward pressure on housing affordability in the US. While real estate is presented with various challenges due to broad economic uncertainty, we do not see a significant risk of defaults in the broad residential market. | + | We are opportunistic on credit risk transfer (CRT) securities as well as non-QM deals that present attractive borrower profiles and higher credit qualities. |
| Non-Agency Commercial MBS (CMBS) | Negative office sentiment has pervaded the market, leading to broad-based risk-off approaches by many participants. Underlying fundamental performance remains generally benign, with limited distress outside of the office sector. Worst-case scenarios are priced in to most subsectors. | +/- | Both new-issue conduit and secondary single asset/ single borrower (SASB) present compelling opportunities to lend on high-quality collateral with acquisition or cash-in financing. |
| Asset-Backed Securities (ABS) | We are cautious on consumer fundamentals and watchful of credit deterioration on lower-credit consumers. We prefer higher-quality consumer sectors, established sponsors and sectors with positive tailwinds. | + | We are focusing on senior AAA bonds across higher credit quality consumer sectors and on-the-run commercial ABS sectors. |
| Inflation-Linked | |||
| US | US TIPS real yields are attractive at levels above prior cycle highs, and breakeven inflation (BEI) levels are close to Fed targets throughout the curve. Although we expect disinflation trends to continue, TIPS now represent good value outright and, in most risk scenarios, relative to USTs. | + | Longer-dated BEI are a good value versus nominal USTs in our base case, but could be attractive as a diversifier within US bond portfolios. |
| Europe | ECB tightening is beginning to gain traction via lending channels and lower headline and core inflation. Goods demand prospects look soft going forward and production tailwinds have lessened as backlogs have been filled. Services, a strong point, have begun to slow. Core inflation will weaken further in 3Q23 and headline will fall sharply in 4Q23. | - | The market is currently pricing a terminal policy rate closer to 4.0% in September. 30-year breakevens are pricing 2.75% versus a 30-year average of around 1.75%. We remain underweight inflation at this tenor both versus the US and in outright terms. |
| Japan | Inflation-linked JGBs remain undervalued as the current 10-year BEI is well below 2%. Inflation is expected to continue to rise, but then moderate in the second half of 2023. However, underlying inflationary pressures are proving stronger than initially expected, as suggested by a more sustained rise in core inflation than expected. | + | We maintain an overweight to Japanese real yields against nominal yields. |
| Municipals | |||
| US | Municipals continue to offer attractive value for investors subject to tax rates, as tax-exempt yield levels remain near decade highs. Despite the potential for an economic slowdown, traditional state and local revenues remain near record levels which should support credit conditions. | + | We continue to favor longer duration securities and also prefer lower-rated IG securities that can benefit from the resilient credit profile of state and local municipal securities. |
| Emerging Market (EM) Debt | |||
| EM Sovereigns (USD) | Positive developments in global inflation and resilient US growth have incrementally improved the outlook for EM assets. We continue to view global central bank policy, commodity prices and geopolitics as key macro drivers of EM returns. | + | We believe HY frontier sovereigns represent the best 2023 total return opportunity in EM given wide valuations and improving support from global investors. |
| EM Local Currency | EM central banks’ proactive tightening measures over the past two years have set up a more positive outlook for both rates and FX in 2023. We expect certain Latin American central banks to start cutting rates in 2H23 even in the absence of cuts by the Fed. | + | While FX will remain highly macro-driven, signs of the peaking of both EM price pressures and policy rates provide the opportunity to add exposure to EM local rates. |
| EM Corporates | EM corporates continue to maintain strong balance sheets, but we are watching the liquidity of domestic-focused issuers given higher local rates and tightened global financial conditions. | +/- | Given comparatively tight valuations relative to DM corporates, we are focused on EM primary issuance at a concession to secondary. EM corporates’ lower duration and volatility may be ideal for clients looking for a more conservative allocation to EM. |