After an unusually bad year for global public markets, the general expectation is that 2023 ought to see fixed income bounce back as an asset class on the back of rising interest rates.
The US Federal Reserve (the Fed) announced its latest policy decision on February 1, hiking the benchmark interest rate by an expected 25 basis points, scaling back after a year of larger-scale hikes noting that inflationary pressures have eased. This will, in turn, influence interest rate policies in other markets.
The Fed's benchmark rate is now in the range of 4.5%-4.75% - the highest since 2007.
Fed chair Jerome Powell insisted that rate cuts are not in the offing, and took pains to walk what has become an increasingly fine line between the flow of data showing inflation in steady decline with the need to keep the public and investors attuned to the fact that interest rates will continue rising albeit at a slower pace.
With inflation still high and demand in the economy stronger than what many experts anticipated, Powell said it remains unclear just how much higher rates will need to go.
Against this backdrop, AsianInvestor asked asset managers what kind of performance will fixed income show for Asian investors in 2023, and where they could get the best returns.
The following contributions have been edited for clarity and brevity.
Aninda Mitra, head of Asia macro and investment strategy
BNY Mellon Investment Management
We suggest reducing our underweight in Asia fixed income especially in emerging markets in Southeast Asia, with an emphasis on local rates and high-quality corporate US dollar bonds.
Three fundamental reasons underpin our investment suggestion.
First, a top-off in the strength of the US dollar should sustain larger portfolio flows into the region.
Second, inflation has peaked across most of emerging Asia at lower levels than at most, reserve currency issuing, developed markets.
Third, much of Southeast Asia (and India) is poised to sustain medium-term growth rates which will likely exceed those at China.
Fourth and finally, we expect China’s re-opening to provide a much-needed boost to regional services and some manufacturing activity which will offset much of the drag from any slowdown in the US or in Europe.
All in all, the region provides attractive valuations (decent real yields vs. inflation expectations, and a respectable yield spread (over USTs) and seems better insulated, relative to the last 2-3 years, against a range of external risks.
Freida Tay, fixed income institutional portfolio manager
MFS Investment Management
While macro risks remain elevated, fixed income starting yields are at levels not seen in years, providing some ability to absorb rate increases in the near term.
Today’s fixed income yields range from around 4.8% (global investment grade credits) to more than 8% respectively for emerging markets (EM) and high yield.
At these levels, an actively managed fixed income portfolio may help Asian investors navigate the markets and generate returns within the fixed income universe, without having to sacrifice liquidity.
Market dispersion has also increased. European credits appear cheap versus the US and potentially offers relative value opportunities. There could also be two potential upsides for EMs.
Firstly, with China still playing a substantial role as a global growth driver, EMs could benefit from China’s re-opening. The second upside risk is the USD weakness.
A weaker dollar typically helps promote capital inflows to EMs, which alleviates EM governments’ financing constraints and fiscal positions. EM local currency debt, which involves EM currency risk, would also be particularly well positioned to perform, should the USD face a correction in the period ahead.
Security selection and active risk management would be key when thinking about generating alpha for investors in this asset class.
Vincent Mortier, group chief investment officer
As central banks’ policy narratives continue to evolve, we stay active on duration and remain slightly cautious mainly through the US, Europe, the UK and Japan.
We are also exploring opportunities across different yield curves and are slightly reducing our curve flattening views in Europe.
On peripheral debt, our close-to-neutral stance remains in place. Although we acknowledge the positive sentiment as CBs show their willingness to reduce the magnitude of future rate hikes, we remain skeptical about rising risk in credit.
We maintain our slightly positive stance, with a preference for IG and Euro subordinated financial debt.
But we avoid highly leveraged names because corporate cash balances are deteriorating and earnings concerns persist. In particular, we remain cautious in HY.
In US fixed income, we are witnessing mixed signals, with resilient employment and consumer balance sheets but weak money supply and inverted yield curves. Core services inflation remains sticky, which is likely to keep the Fed on the tightening path.
In this environment, we remain active on duration, with a bias towards neutrality.
We have a similar active approach on TIPS, which look to be reasonably valued. In credit, we remain highly selective, with a preference for financials over industrials and with a strong focus on liquidity.
We also generally favour higher-quality segments. In securitised markets, given the interest rate volatility, investors should be flexible, particularly in agency MBS.
While consumer fundamentals currently remain strong, they may feel the pressure as excess savings erode.
On EM bonds, we see opportunities in 2023, thanks to some stability in core US rates. Spreads currently offer a compelling entry point for HC, and in LC, valuations are attractive.
We are evaluating how a potential US dollar weakening and China reopening could affect Chinese bonds. In LatAm, while we like Brazil, we are monitoring policy evolution.
Ben Bennett, head of investment strategy and research
Legal & General Investment Management (LGIM)
Last year was nothing short of a disaster for fixed income investors, but that means that 2023 starts with far higher yields.
So while headline and market volatility will probably remain elevated, at least you’re better compensated for the risk.
That said, we think the first half of the year will be difficult for developed market credit, particularly after such a strong January which has sent spreads back to levels normally seen in benign growth conditions.
We think a recession in the US and Europe is more likely than not, impacting profitability and sending credit spreads wider.
So we’d be cautious right now, focusing on shorter-dated high quality credit where you get the benefit of an inverted yield curve.
We’re more positive on emerging market credit, which benefits from a relatively strong growth outlook, boosted by China’s reopening. We particularly like local currency credit given the downward turn in the US dollar.
If we’re right and developed market credit spreads widen as recessions take hold, we would be looking to add risk later in the year because our bottom-up stress test suggests issuers are well placed to weather an economic downturn. That applies to both investment grade and high yield asset classes.
Chang Hwan Sung, portfolio manager
Invesco Investment Solutions
Market sentiment continues to improve, and our barometer of global risk appetite continues to improve, led by tightening in EM sovereign bond spreads and US dollar depreciation, and outperformance in emerging market (EM) equities.
We should be careful not to over-interpret this change in sentiment.
We think the expected improvement in growth is unlikely to represent the beginning of a new economic cycle; it’s more of a repricing of near-term recession risks, which have receded somewhat.
It’s notable that the inversion in the yield curve remains meaningful and persistent, a reminder of elevated growth risks driven by tight monetary policy, and the Fed’s objective to stay restrictive until inflation has converged back to 2%.
The latest inflation reports in the US confirm a gradual abating of price pressures, increasing the likelihood of the Fed signaling a pause in the tightening cycle which would further support the recent rebound in global risk appetite.
Against this macro backdrop, in fixed income we are tactically overweight risky credit via high yield, bank loans and emerging markets hard currency debt, given above average spreads and improving risk appetite.
In this environment of below trend and improving growth, risky credit offers an attractive tactical opportunity for equity-like returns with lower volatility.
This is funded from investment grade and government bonds, while we maintain a neutral duration stance relative to benchmark. We expect additional compression in breakeven inflation expectations as inflation momentum continues to slow, hence favor nominal over inflation-linked bonds.
Geoffrey Lunt, head of Asia investment specialists, Hong Kong
HSBC Asset Management
The yield and income story is back in 2023, with corporate and even government bonds offering prospective returns far higher than in much of the period between the global financial crisis and the COVID pandemic.
For times during that period, it felt as if the world was stuck in a vicious circle of deflation and central bank stimulus which would depress bond yields indefinitely, but the disruption to the global economy taught us that supply chains could be fragile in the event of a severe shock and inflation took hold quickly.
This eventually skewed the risk/ return in fixed income markets back in the investors’ favour around the end of 2022.
Unless inflation was to remain at very elevated levels for a protracted period, which always seemed unlikely, investors could either take advantage of higher interest rates temporarily, and enjoy capital gain when central banks returned to stimulus mode in the face of slowing economies, or maintaining the higher levels of carry if interest rates remained high and stable- remember that we don’t need rates to fall to make decent returns when yields are high.
With its wider spreads and positive macro drivers, especially in relation to the reopening of China, we especially like Asian credit and local currencies this year, and similar for global emerging markets bonds.
Michael Collins, senior portfolio manager, multi-sector strategies
PGIM Fixed Income
While interest rates and risk assets may continue to experience more volatility in the short term, significant value has been created for the long-term fixed income investor.
The renaissance of higher yields restores the balance to the asset allocation mix and should be warmly welcomed by investors and savers.
As corporate fundamentals remain solid, credit quality and ample liquidity should enable corporations to better weather an economic downturn without raising default rates significantly.
The sell-off in bonds in 2022 pushed global yields higher, creating good value opportunities in fixed income markets.
If interest rates remain rangebound at these higher levels and/or decline marginally as economic and inflation data continue to cool and central banks respond with precautionary rate cuts in the second half, investors would do well to build up their bond exposure based on the shifting environment.
Playing the short end of the curve may be beneficial as we approach peak central bank rates, while adding duration may help boost total returns if the Fed pauses and begins to cut rates later in the year or in 2024.
Adding to risk assets like high yield and emerging market debt may be beneficial later in the cycle once the Fed begins cutting and the U.S. dollar softens—or in the event that the Fed is successful in engineering a soft landing.
Mark Baker, head of fixed income, Hong Kong
Asian investors should have high expectations for fixed income returns in 2023, after a dire year for bond performance last year.
The first piece of good news is that the starting point for global policy rates is now at multi year highs, meaning most central banks, including the US Fed, will be concluding their tightening cycles in the coming months.
Further good news is that Asian investors don’t need to look far from home for good fixed income investment opportunities.
Some central banks in the region have arguably already reached their terminal policy rates, in places like Korea, India and Indonesia, meaning the market is likely to start pricing in cuts as the next policy step, forcing down bond yields.
Even in China, where a strong economic recovery is set to take hold as the country emerges from zero covid policy, we expect the next policy actions to be carefully and patiently calibrated.
Meanwhile, we are relatively constructive on Asian currencies as a pause in the Fed cycle is likely to ease appreciation pressure on the US dollar.
At the same time, a pick-up in import demand from China and the return of Chinese outbound tourism should support regional currencies to varying degrees.
Outside of local currency government bond markets, we also see better returns ahead for Asian US dollar credit. We view the asset class as an attractive source of US dollar income and expect investors to re-engage now the worst is over for China property related assets.
We see selective opportunities across Asian investment grade and high yield markets, but recommend investors manage downside risk by fully integrating an analysis of ESG risks into all investment decisions.
Greg Wilensky, head of US fixed income and portfolio manager
Janus Henderson Investors
While the inflation-driven increase in yields was painful for fixed income investors in 2022, bonds are now offering the most attractive combination of yield and diversification seen since the Global Financial Crisis. With most of the increase in rates behind us, we expect the backdrop in 2023 to be about declining inflation and slower growth.
Therefore, we believe fixed income investors have more to look forward to in 2023, and that now is the time to lean into higher yields.
While we have a positive outlook on fixed income, we do not believe all sectors are equally attractive on a valuation basis.
For example, spreads in securitized sectors are trading much wider than their 10-year averages, whereas corporate bonds are still trading near their long-term averages.
As such, we think securitized assets better reflect the likelihood of slower growth and look attractive relative to corporates. In our view, an experienced active manager can seek to take advantage of these relative value opportunities in the pursuit of better risk-adjusted returns.
We are more optimistic for fixed income in the year ahead as we think bonds are well positioned to provide the income and diversification benefits in 2023 that investors have come to expect from their core fixed income allocation.
Kheng Siang Ng, Asia Pacific head of fixed income
State Street Global Advisors
Asian central banks have made significant rate hikes in 2022 to address rising domestic and imported inflation in the face of currency weakness.
This year one would expect that with Asian central banks close to the end road of rate hike (with some central banks pausing at recent meetings or made comments that rates at current level is deemed sufficient and appropriate under current macro developments), sentiments towards Asian local fixed income markets would improve.
In addition, Asian currencies would be expected to perform better in 2023 as US dollar strength is expected to peak soon.
Investors have been underweight risky assets for most of last year and we expect inflows (since the start of the year) into emerging markets including Asia would continue as fixed income outlook improves.
A reasonably conducive net bond supply situation also would underpin the resilience of Asian fixed income markets.
Asian local rates and hard currency credit would be the areas for investors to do well this year as rate hike concerns subside and wider credit spreads would make valuation attractive. Interest rates dynamics within Asia would differ.
China reopening would likely begin to yield positive growth outcome in coming months once Covid cases stabilise. Thereafter bond yields may gradually rise.
Outside of China, interest rates are expected to peak soon, leading to better buying of bonds by investors. On the whole, a more encouraging Asian fixed income outlook is expected for 2023.
Matthew Holdgate, portfolio manager and senior analyst, global fixed income
Nikko Asset Management
We remain highly constructive on high quality sovereign bonds in 2023. Valuations are extremely compelling, particularly relative to equities, where the relative yield advantage is at its highest since the global financial crisis.
We expect to see a significant disinflationary environment with official inflation prints tracking declines in business surveys and commodity prices.
While there remains uncertainty as to whether core inflation will decelerate to the same degree, we are now starting to see declining job vacancies and easing wage pressures which should see the Fed end its hiking cycle in the coming months, with an inverted yield curve flashing a warning sign of a potential overtightening.
Meanwhile, in Europe despite the improving energy situation the ECB has remained adamant in its goal to hike interest rates further, partially, in our view, due to the delay in commencing monetary policy normalisation, hence the lagged effects of previous rate hikes are yet to materialise in weaker demand indicators.
As such we prefer US treasuries relative to European government bonds at this juncture, particularly shorter dated maturities.
Furthermore, we prefer to avoid Japanese government bonds given unattractive valuations, and a belated shift from the BOJ to normalise its ultra-accommodative monetary policy.
Philipp Burckhardt, fixed income strategist and portfolio manager
Lombard Odier Investment Managers
We believe 2023 marks the return of fixed income as an attractive proposition for asset allocators, as we rise from an unparalleled market correction last year, which has resulted in the highest all-in yields in a decade.
This has two key implications: high carry protects investors even if volatility remains elevated or yields were to rise somewhat more, and secondly, the opportunity cost to avoiding fixed income today is much higher, fueling demand.
We believe 2023 is the year in which central banks hit the peak of their interest tightening cycle with the US leading Europe but are not yet convinced a proper change in course is warranted to the extent as is currently priced-in by markets.
Consequently, we think financial conditions will remain tight and volatility will remain a feature of this year’s environment, which is best summarized in our conviction to overweight corporate credit.
We do this, by moving up in quality as we believe the riskiest part of credit will be challenged more by today’s stage of the cycle.
We see a sweet-spot in fallen angels (investment grade bonds downgraded into high yield), the crossover segment and investment grade, where fundamentals and balance sheets looked strong and robust.
Jeff Klingelhofer, co-head of investments
Thornburg Investment Management
Monitoring the direction of inflation is the most important consideration for fixed income investors this year. Structural impediments, specifically tight labor markets, prop up inflation and may keep it stubbornly high.
The implications of higher inflation drive equity and fixed income correlations, and thus asset prices and asset allocator decisions.
While 2022 was a supremely unusual year in which both equities and fixed income prices marched in the same direction – down – I believe that the role of fixed income in an investor’s portfolio will normalise this year.
But it’s not just prices that we should watch.
The income component of fixed income today is tremendously interesting.
Core portfolios easily generate 5 to 6% yields. Investors should be mindful not to reach for yield at all costs, but instead appreciate fixed income’s typical defensive nature behavior.
The US consumer and high yield are two themes we believe investors should explore for their potential returns.
The US consumer has had the lowest delinquency ratios in economic history. And while the economy is slowing, the strong starting position cushions the impact of potential recession.
With a steady stream of opportunities, we are putting cash to work in high yield.
Investors must be mindful of high yield induced volatility, so these positions are still small in our portfolios. But on a long-term basis, the yields are more compelling today than we’ve seen for some time.
Mabrouk Chetouane, head of global market strategy
Natixis Investment Managers
The pause in the Fed’s hiking cycle we foresee in H1.23 should provide a stabilisation in US Treasury rates and be a catalyst for a decline in rates volatility overall.
However, while we can find attractive yields across most segments nowadays, investors should favor higher-quality bonds to hedge against the many risks still present.
On a regional basis, we favor US government bonds, especially long-term ones given current late-cycle conditions, and stay away from European ones as the market underestimates the ECB’s determination to continue hiking rates amid a core inflation has yet to peak.
We also like emerging sovereign debt, both in hard and local currency terms, as the US dollar depreciation, the likely ease in EM monetary policies as well as the reopening of China should both be a catalyst for inflows.
Shifting to corporate debt, with now several months anticipating an incoming recession, companies should be prepared for a shallow recession, but the eventual impact will be determined by its final depth and duration.
As such, we remain cautious and favor US and EU investment grade bonds against lower-quality buckets.
Jonathan Liang, head of Asia ex-Japan investment specialists, global fixed income, currency and commodities
J.P. Morgan Asset Management
In a year where global central banks’ tightening is expected to bring about an economic slowdown and potential recessions in developed countries, volatility could remain elevated in risk assets.
We believe that against this backdrop, fixed income can once again play an important role in client portfolios.
At the current juncture, we would be leaning towards high quality, short-dated credit, mainly investment grade corporate bonds as well as securitized assets.
However, as the economic slowdown deepens, we think that lower quality credits, such as US high yield, may start to see spreads widen, and may become an opportunity in the second half of 2023.
Overall, given the dramatic upward move in yields we saw in 2022, you can see from the chart that various fixed income sectors are now offering very compelling risk-return potential. In 2023, we believe fixed income will become fashionable again.
Murray Collis, chief investment officer, fixed income (Asia ex-Japan)
Manulife Investment Management
We expect 2023 will be more predictable and potentially more accommodating in terms of the global macro environment.
In view of that, Asia should be a primary beneficiary of stabilizing macro environment as its growth profile remains resilient; however, the region could advance at different speeds.
China’s faster-than-expected relaxation of zero-COVID policies and border opening should ultimately be a key driver for growth in 2023- although there are likely to be challenges along the way.
Asia ex-China economies are also expected to benefit from this positive spill-over via increased trade and tourism depending on its economic ties with China.
Overall, we believe this dynamic should contribute to investment grade’s continued performance and a potential rebound in high-yield with narrowing credit spreads.
We believe Asian credit is poised to be the main contributor to fixed income returns in the new year, and our proprietary research leads us to be constructive on a few sectors this year: China property, Macau casinos, China industrials, and India renewables.
We are constructive on selective segments of China property.
We believe November marks an inflection point in terms of policy measures. These measures, known as the ‘Three Arrows,’ are viewed by the market as the most comprehensive and coordinated policy response since the start of this crisis.
We will continue to closely monitor primary market sales transactions, which we believe is vital for a sustainable recovery in the sector.
China industrials have been beaten down amid negative sentiment towards China’s property sector and concerns about slower economic growth. Yet, the sector benefits from an outsized connection to state-owned enterprises and government support. Given current valuations, a marginal improvement in economic growth from the country’s reopening and knock-on effects should result in better performance and tightening spreads.
Macau casinos have experienced difficult times over the past two years due to reduced tourist flow and lower revenue amid stringent COVID-19 curbs. As a result, valuations are attractive compared to the historical average. We believe the sector could benefit from the current reopening of borders in early 2023. With the E-visa system for mainland visitors relaunched in early November, we believe tourism and improved business fundamentals should ultimately rebound from the current trough.
Chris Wong, investment director Asian fixed income
2022 was an exceptionally tough year with rising inflation, financial tightening, and geopolitical risks.
Despite these headwinds, Asian bonds delivered resilient performance due to solid fundamentals and the fact that the central banks’ adherence to conventional monetary policies during the height of the COVID-19 pandemic resulted in a less inflationary environment compared to the major developed markets.
After a perfect storm, we are optimistic about the opportunities that lie ahead in Asian bonds as the macro backdrop is turning favourable. In 2023, we anticipate that inflation will continue to moderate from elevated levels.
US rates have peaked, strength of the US dollar will further soften as the Fed is near the end of its tightening cycle, and growth differential between the US and rest of the world continues to narrow.
From a valuation perspective, bond yields are also looking more attractive after the significant repricing seen last year.
Within fixed income, we see pockets of opportunities in both the Asian local currency sovereign and Asian US dollar denominated credit space.
While the former is a heterogeneous asset class that offers Asian currency exposure, risk diversification benefits and plenty of relative value trading opportunities, the latter is a place where investors can find attractive carry and take advantage of improving corporate fundamentals.
In the Asian local currency sovereign space, we are constructive on regions with solid fundamentals where the central banks are early hikers and real yields are attractive, such as Singapore, South Korea, and Indonesia.
Indian rates will likely underperform given unfavourable demand-supply balance and expected weakness of the Indian rupee, in our view.
In the Asian US dollar denominated credit space, we prefer investment grade over high yield as the segment now yields about 5.5% for approximately 4 years of duration, offering attractive risk-adjusted income. Our preferred sectors include financials, higher quality sovereigns, quasi-sovereigns and selected technology names.