This analysis is by Bloomberg Intelligence Chief EM Credit Strategist Damian Sassower and Bloomberg Intelligence Rates Strategist Ira F. Jersey. It appeared first on the Bloomberg Terminal.
Central bank policy tightening has started to subside as inflation and growth expectations recede across most major economies across the globe. Fixed-income performance expectations at Bloomberg Intelligence are responding positively, with all 13 asset classes under coverage posting a quarterly increase in 12-month total return projections.
Keep it simple as inflation impulse weakens
Performance expectations are on the rise across global fixed income, as all 13 asset classes under coverage at Bloomberg Intelligence posted a quarterly increase in 12-month total return projections. Set to lead the fixed income universe are increases in UK gilts (which we forecast up 12%), US mortgages (9.5%), European high yield (9.2%) and municipal bonds (9%). Conversely, US high yield (up 4%), Japanese government bonds (4.5%), China government bonds (4.7%) and EM local debt (6%) are projected to trail fixed income peers over the 12-month period through June 2024.
Central banks are no longer tightening aggressively, causing bond market participants to prepare for dovish pivots in monetary policy. Real interest rate differentials between Europe and the US may tighten more, with non-dollar debt well positioned to benefit.
Optimal portfolios offer improved asymmetry
Our fixed-income efficient frontier exhibits improved risk-return asymmetry, as underlying Sharpe ratios reflect higher total return expectations and a more stable risk-free rate. In every optimal portfolio combination along the efficient frontier, US Treasuries, US mortgages and US municipals are afforded the maximum allocation possible. Conversely, Japanese government bonds and emerging market local debt receive the minimum allowable allocation in all optimal portfolios along the frontier.
Our core analysis employs US Treasury yield estimates of 2.98% (two-year), 3.05% (five-year), 3.11% (10-year) and 3.40% (30-year) when calculating 12-month total-return forecasts for our efficient frontier (dark blue). Click the exhibit to construct optimal mean-variance portfolios, as conceived by American economist Harry Markowitz.
Return seekers should consider European credit
Investors seeking to maximize total returns may consider swapping US investment grade and high-yield debt for euro-denominated credit. Based on our 12-month projections, European investment-grade and high-yield credit should command a larger share of portfolio exposure as investors add risk, with their combined weight peaking at nearly 10% of the maximum return portfolio. Conversely, US investment-grade and high-yield credit combine for just 7.5% of the maximum return portfolio, down from 19.1% in the minimum risk portfolio.
Non-dollar asset classes comprise just 31% of the minimum risk portfolio, yet this figure climbs to 47.5% when investors elect to maximize total returns. European treasuries and UK gilts combine for just 10% of the minimum risk portfolio, yet exposure climbs to 25.2% in the maximum return portfolio.
Carry offers better support for bond bulls
Falling growth and inflation expectations are bullish for diversified fixed-income investors, yet year-to-date performance is largely a function of carry. The Bloomberg Global Aggregate Bond Index is up 3.1% in 2023, as the benchmark continues to rebound from last year’s record 16.3% loss. Year-to-date returns are largely a function of time, with carry delivering 181 bps of positive attribution. Credit risk (spread) is responsible for 23 bps of upside in 2023, with declining bond yields (duration) contributing another 19 bps of positive attribution.
Currency movement is responsible for 62 bps of downside this year, as spot foreign exchange remains the greatest risk facing global creditors. The index is now running at a 1.4% loss since December 2012, with foreign exchange accounting for the majority of negative attribution.
Banking on broad-based bond market strength
The rally in global fixed income could extend into the second half of 2024, as all 13 asset classes under Bloomberg Intelligence coverage are expected to deliver a positive total return over the next 12 months. Of the 13 fixed-income asset classes under coverage, 12 are up on the year, led by European high yield (up 10.6%), emerging market local debt (8.8%), European investment grade (8.1%) and European treasuries (7.5%). Broad-based bond market strength stands in stark contrast to last year when not one fixed-income asset class generated a positive full-year return, and 12 of the 13 posted double-digit losses.
Japanese government bonds (down 3%) are the worst-performing fixed-income asset class in 2023, followed by China government bonds (up 0.4%), US Treasuries (up 1.7%) and US mortgages (up 2.1%).
Bloomberg
Source link
