Our core view is that the central banks are not going to deliver the level of hikes that is priced into the bond market.
POLICY RATE PATHS
Central Bank Divergence: Are Markets Pricing Too Many Rate Hikes?
I think one of the most interesting things about the bond market right now is the divergence that we’re seeing among the policymaking paths of the major central banks. We’ve got a chart here up on the screen, and what this shows is the evolution of the overnight rate, the policy rate, for four of the major central banks: the Fed in the U.S., the Bank of England, European Central Bank and the Bank of Japan.
What you can see is that there was, over the last few years, a lot of consistency. We saw hikes in COVID in the inflation period and then eases as that inflation and that economic cycle morphed.
But where we sit today is a period of divergence. What has been this divergence looks to us like it’s going to be a little bit more of a coordinated, albeit slow, hiking cycle from a lot of these different countries. But I think one of the other really interesting things about this is it’s largely priced into the bond market right now.
Our view, our estimation, is that we will get some hikes, but it’s not going to be the magnitude that is currently priced into these bond markets.
GROWTH EXPECTATIONS
Global Growth: What It Means for Bond Yields
Bond markets and bond yields are really driven by what is going on with economic growth and inflation. What we’ve got up on this chart is current and then also projected consensus growth rates for four of the big countries or regions in the world.
You see growth for the U.S. really around 2% to 2.5%. Growth rates then for the UK, Europe and Japan. In those three areas, growth rates are closer to that 0.5% to 1.5% type of range.
I think there is a bit of this perception in the market that growth rates are really expanding or increasing at a much faster rate, and that’s really not borne out by the facts.
PORTFOLIO POSITIONING
Where to Find Opportunities in Fixed Income Now
On the interest-rate front, our core view is that the central banks are not going to deliver the level of hikes that is priced into the bond market. What that really means for investors is focus on strategies and investments oriented around the short maturities – anywhere from a six-month to a five-year type of investment horizon, where you’re really capturing a lot of the elevated yield levels because of the hiking cycle that is priced in.
On the credit side, that growth environment supports a range of income and credit instruments. Whether it’s something in the loan area where you can capture a floating-rate instrument with a little bit of extra spread, or maybe a short-duration investment-grade income portfolio, that also marries up some of the components of what we were chatting about on the interest-rate side.
As central banks hike, Ashok Bhatia, CIO and Global Head of Fixed Income, explains why we expect fewer rate hikes than bond markets currently price and how that view is informing our approach to duration and credit. Our core view is that the central banks are not going to deliver the level of hikes that is priced into the bond market.
Three key takeaways
- We expect a “coordinated, albeit slow, hiking cycle” from central banks. But importantly, “it's largely priced into the bond market right now,” according to Ashok Bhatia.
- The view that AI is driving economic growth at accelerated rates is not borne out by the data.
- Market expectations on the number of hikes and the terminal rate for the fed funds rate may be overstated.
For investors, opportunities may lie in shorter-maturity bonds, roughly six months to five years, as yields remain elevated in that part of the market, allowing investors to capture income without having to move much further out the curve.
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