In the second episode of Allspring’s 2023 outlook series, George Bory, chief fixed income strategist, and Katie D’Angelo, global head of Relationship Management at Allspring, discuss the opportunities across the global fixed income landscape.
George Bory: The good news from our perspective is that last year’s repricing in the bond market is really this year’s opportunity. And it’s our job as portfolio managers to identify them, to wrap them all up into portfolios, and ultimately deliver it to clients.
Katie D’Angelo: That’s George Bory, chief fixed income strategist for Allspring Global Investments. I’m Katie D’Angelo, global head of Relationship Management here at Allspring, and you’re listening to On the Trading Desk®. Today, we’re discussing Allspring’s 2023 fixed income outlook. Thanks for being here, George.
George: Thanks for having me on, Katie.
Katie: First off, George, investors are hopeful for a recovery in fixed income markets here in 2023. What do you think are the biggest threats to that outcome?
George: The big difference between last year and this year, we think it’s ultimately going to be that trajectory. Does inflation come down? How fast does inflation come down? And what’s the policy response to that? Tied up in that will ultimately be how asset prices react. And so, when we think about challenges and when we think about risks to this year, as a bond investor, I’m worried about preserving my purchasing power in the future. And so, the good news from our perspective is that last year’s repricing in the bond market is really this year’s opportunity. And it’s our job as portfolio managers to identify them, to wrap them all up into portfolios, and ultimately deliver it to clients.
Katie: So, do you think that the Fed (Federal Reserve) can actually control inflation? And what tools do they have to do that with and what’s the odds of them getting that right at the right time?
George: The Fed’s job is to control the economy. They need to maintain an inflation rate that’s kind of healthy for the U.S. economy that encourages investment, that allows people, individuals, as well as corporations, and governments and other entities to make good economic decisions and to keep the channels of credit open. We know that they have the tools that can affect demand. It’s Fed Funds. It’s balance sheet management. And when they use those tools, they ultimately get what they want. And so, we do think they will get inflation under control. And so, we look at one key variable. Historically, the Fed has gotten Fed Funds above the spot rate of inflation long before they consider cutting rates. Now, we think sometime in the first half of this year, those two lines will cross, but we are not there yet. So, we’re watching for that. And in the lead up to that point, we’re going to expect high degrees of volatility. We’re going to see a lot of uncertainty in the market. And there will be a lot of questions about whether they’re ultimately going to get there. What we take solace in and what gives us reason to be optimistic about the market is we look at current yields. Cash is at 4.5%. So, the average yield on the Treasury market is about 4%. Munis themselves are roughly at about 5% and investment grade corporates are at 6% and high yield is at 8%. At that type of yield level, there’s a significant amount of cushion to absorb that volatility, to take some of that uncertainty, and to circle it back to what I said before, to build portfolios that deliver those very consistent cash flow streams. And that’s what we’re trying to do for clients.
Katie: So, when we look at all those areas of opportunity for investors across the global fixed income landscape, what considerations should they take for yield enhanced strategies?
George: Katie, that’s a great point. And when we look in the here and now, the short end of the curve, so from cash out to, say, the 5-year point on the curve, that looks to be the most attractive part of the curve right now. Now the curve is inverted, so you roll up the curve. But when we look at the aggregate level of yield, what’s priced into the market, both from a Fed perspective, from an inflation perspective, from a growth and risk perspective, we like the yield that’s offered in that sort of segment of the market. And so, if I can get 70% to 80% of the yield, if not more, by taking just a quarter to a third of the duration of the broader market, that’s an attractive opportunity. And so, when we look at that segment of the curve, we see a lot of break-evens. So, the yield itself or the spreads that are available at that part of the curve provides a big, generous buffer to sort of offset any volatility. Because when we think about where vol is today, the break-evens in, say, the 2-year Treasury is about tenfold of what it was a year ago. That’s a meaningful move and a lot of cushion to provide us with a fair degree of comfort. Now, secondly, as you move further out the curve, buying duration makes sense for a lot of investors, especially those with long duration liabilities that they’re managing against. It could be your pension. It could be your college education. It can be liabilities for insurance companies. Yields are looking fair to reasonably attractive, but you should expect a fair degree of price volatility. We are still in an uncertain world. The Fed is still battling inflation. And so, while we’re willing to add incrementally more duration today than we were, say, a year ago, it’s still early days to say you want to own a lot of duration.
Katie: How do you think munis are poised going forward?
George: Munis tend to do well in a rising rate environment and they’re also a nice counter cyclical buffer to the cyclical risks that typical things like treasuries and corporates and mortgages, agencies, all of the more traditional taxable forms of debt, the challenges they face. So, three things: short duration, modest exposure to longer duration, and then we look at munis. Those are sort of the three higher conviction points of the market.
Katie: With the time we have left, George, can you share your top takeaways for what clients should be thinking about right now and how they can potentially take action on?
George: We would boil it down to five basic principles. Number one, duration management. Yields look attractive at the long end. Modestly long duration positions should work for investors. Number two, positive real yields. You want to invest in bonds that have yields that will be your cost of spending sometime in the future. Third, a big part of the market is the corporate credit market. That’s commercial paper. That’s high yield. That’s investment grade. You want to be a little bit more tactical. Moving up in quality is still our overarching theme, the economic outlook is a bit uncertain, and the Fed is still tightening policy. So, you want to be cautious, but you don’t want to give up on it. Fourth, keep a close eye on structured product. Structured products are perhaps the best way to generate stable cash flows in an unstable environment. And then lastly, as I mentioned already, the municipal bond market, it’s a good place to park money, it’s a good place to invest, specifically for individuals who get the benefit of a tax advantage and use that as the cornerstone of their portfolio. So, there is a lot of value in fixed income. There are a variety of ways to approach it. Perhaps the most important takeaway is that actively managed portfolios should do very well, given the heightened amount of volatility, the dispersion of yields across sectors and maturities and the importance of building a cash flow stream that meets the needs of each individual client. That’s what bonds do. That’s what we do with bonds. And that’s hopefully what clients are going to get from us.
Katie: Thank you, George, for being with us today and sharing your insights.
George: Katie, thanks so much for having me. Good luck to everyone this year.
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