How fixed income can (still) provide an anchor to windward
Fixed income investors face a backdrop rife with change, as persistent inflationary pressures, shifting volatility in government bonds, and inconsistent stock/bond correlations are raising questions as to bonds’ role in portfolios.
However, with a continually expanding fixed income toolkit, investors can still find ways to use bonds as a stabilizer, exploit their classic role as a reliable source of income, and help produce desired outcomes in a holistic fixed income strategy.
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Bonds are being tested, but stabilizing role is still possible
Financial markets have endured a range of shocks so far this year but have shown remarkable resilience. While equities have continued to soar to new highs, government bonds have seen volatility and bear flattening alongside shifting expectations for policy rates, inflation, and fiscal policy. Meanwhile, both high-yield and corporate bond spreads remain near multidecade tights (Figure 1).
Looking ahead, bonds face several trends that could put upward pressure on yields across the curve, including:
- A more hawkish Fed and less frequent forward guidance, leaving markets more prone to react strongly to macro data
- Hyperscalers with large capex plans have turned to the debt markets, and while their fundamentals are strong, investment-grade markets still have significant supply to absorb
- The rise in the term premium is a long-term trend that has been driven by inflationary concerns and rising fiscal deficits in nations across the globe
- In addition, stock/bond correlation has reached its highest level in decades (Figure 2), calling into question the role of bonds as a hedge against equities or other high-beta assets
In such an environment, many investors are trying to determine how, and whether, they can use fixed income to play its traditional role as portfolio ballast. Specifically in the pension space, plan sponsors are searching for ways to improve their funding ratios without meaningfully increasing the risk in their portfolios.
Given the expanding menu of ways to access fixed income, investors can look beyond traditional exposures and consider fixed income strategies with qualities that diversify and build portfolio resilience—even when rates are rising and stock/bond correlation has turned positive.
In this piece, we discuss tactics that may help manage risk, improve diversification, and potentially generate additional return.
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