United States
1) Beat the dash from cash
Cash typically beats fixed income when rates rise as longer-dated fixed income gets hit.
But once rates are done rising, fixed income generally reigns supreme (Figure 1). The curve tends to renormalize and locking in higher rates for longer has historically been the dominant strategy for many investors. We are at this transition now. In our view the Fed is done hiking, or at most has one hike left. It’s the ideal time to move out the curve.
Figure 1: We believe it’s the ideal time to move out the curve
Source: Bloomberg, Insight calculations, November 16 2023. Cash: ICE BofA US 3-Month Treasury Bill Index1.
2) Current yields are similar to long-term equity returns
There are rewards out the curve. Bond yields look equity-like (Figure 2) at a time that equity ironically might not. Volatility is a constant threat against a backdrop of high rates, quantitative tightening, and an economic slowdown. We think locking in returns through fixed income is a smart move.
Figure 2: Bond yields currently offer considerable income
Source: Bloomberg, Insight calculations, November 16 2023. Cash: ICE BofA US 3-Month Treasury Bill Index1
3) Fixed income can be a "win-win" for both investors and corporates
Q) What do corporates have in common with a pandemic-era homebuyer sitting on a 30-year fixed rate mortgage?
A) They’re probably not feeling the pinch from rising rates.
Corporate bond yields started rising in 2021. But 75% of IG bonds and 80% of HY bonds were raised before 20212. So, although yields are up, coupons generally aren’t. Investors can secure higher yields and corporates don’t have to pay them — a win-win scenario. US IG bonds have an average 10-year maturity, meaning it would take years for rates to materially impact funding costs.
Beware, though. In floating rate markets (like leverage loans) it’s a different story – those coupons are rising with yields and could be a strain on the issuers (Figure 3).
Figure 3: Corporates with fixed coupons aren’t feeling the pinch from higher yields, but beware of floating rate markets
Source: Bloomberg, Credit Suisse, November 2023, *Leveraged loan data as at October 31, 2023. IG Corporates: Bloomberg US Corporate Investment Grade Index. HY Corporates: Bloomberg US Corporate High Yield Index. Leverage loans: Credit Suisse Leveraged Loan Index. See index descriptions at the back of the document. Past performance is not indicative of future results. Investment in any strategy involves a risk of loss which may partly be due to exchange rate fluctuations.
4) Beware the incredible shrinking illiquidity premium
Speaking of floating rates, those tend to be the coupons of choice in private illiquid credit, too. That’s one reason for pause.
But the major one is the evaporating “illiquidity premium.” Private credit was certainly attractive when rates were zero, but now we believe it’s time to pivot back to liquid fixed income (Figure 4).
Figure 4: As rates have risen, the illiquid premium from private debt has compressed
Source: Bloomberg, S&P, November 2023. HY Corporates: Bloomberg US Corporate High Yield Index. Leverage loans: Credit Suisse Leveraged Loan Index. Illiquid credit: MarketVectorTM US Business Development Companies. See index descriptions at the back of the document. Past performance is not indicative of future results. Investment in any strategy involves a risk of loss which may partly be due to exchange rate fluctuations.
5) Stay active, it's a bond-picker's market
Looking ahead, we think investors need to be intentional about the fixed income risks they seek and stay nimble.
Be an opportunist
A capex supercycle may be kicking off as manufacturing returns to the US at breakneck pace due to federal incentives. New manufacturing plants have been the leading lights of business investment in the latest GDP reports. Compelling opportunities may arise for opportunists – as long as you stay nimble. So far, we have seen value in some of the large, established bond issuers in the auto, semiconductor and electronics, and biomanufacturing businesses that have opened new factories. We believe this may add diversification benefits and help insulate reshorers from political risk.
Figure 5: A capex supercycle could directly or indirectly create opportunities in credit
Source: The White House, November 2023
Careful – some things could still break
As we saw with the banking crisis early in 2023, rising rates can break things. An area that still looks dicey to us is commercial real estate, which still has not recovered from the pandemic and deserves utmost caution (Figure 6).
Figure 6: Commercial real estate is still worth treating with utmost caution
Source: Bloomberg, November 2023
High quality credit looks particularly attractive, for now
We think we are entering a fixed income golden age3.
High quality debt alone currently offers plenty of yield and should be the backbone of any fixed income allocation. We particularly like investment grade pipelines, utilities, and large money center banks. Off the beaten path, we also see value in the complexity premium from quality senior structured credit, particularly CLOs.
Elsewhere, in high yield, a short-dated approach can be attractive given compelling cashflow visibility over short timeframes. Broad high yield also offers value if you can maximize diversification and liquidity.
