Is there still value in fixed income?

Fixed income, after the everything rally

In November and December, total returns from global stocks and bonds were more than the average annual return on the S&P 500¹ since 2000. Despite the rally, we still expect stocks and bonds to outperform cash in 2024, even if some expected 2024 returns were pulled forward to 2023.

The everything rally was historic and driven by a rapid rebalancing in the US economy and Fed commentary that suggests rate cuts may be delivered sooner than previously expected.

Most economic indicators have returned to pre-COVID levels but despite a normalization of the economy, policy rates are NOT. At the December Federal Open Market Committee (FOMC) meeting, Chair Powell commented that the Fed is “very focused” on not staying too tight for too long; this comment suggests the Fed is incrementally supporting the growth outlook versus fighting inflation. Recession risk is not gone, but it has declined measurably over the last 6 months as the economy has rebalanced and the Fed has signalled its willingness to adapt its policy stance.

The story in Europe is similar, where markets price a total of 150bps of easing in 2024 as macro data has continued to come in below expectations since the European Central Bank (ECB), delivered its final hike in September. We do not expect a meaningful turnaround in growth without significant easing from the ECB. 

Despite the everything rally, we expect carry to drive 2024 fixed income returns.

Since October 10-year Treasury yields have declined by +/-100bps, driving the U.S. Aggregate Bond Index² to the biggest two-month total return since 1982. Some investors suggest there isn’t any value left in fixed income - we disagree. The rate rally has been swift, but the bond market is now pricing what we think the Fed will do in a soft landing, namely:

1. cut rates this year,
2. cut around 200bps over a 2-year horizon and
3. settle around 3.5% thereafter.

This mix is consistent with a 10-year Treasury yield around 3.75% at the end of 2024 (vs. 4% at the time of publishing).

Investing in fixed income

1) For strategic investors that are still underweight duration, current yields are still attractive and we expect carry-like total returns in 2024. In the unfortunate event we hit a recession, we expect bonds to serve as a hedge to other asset classes and offer compelling total returns.

2) For tactical investors, we see more relative value in the front end of the curve. In 2024, we expect similar total returns as longer duration fixed income, but with less volatility

3) Diversify: Euro Investment Grade Index (EUR IG)³ offers value and should favor dollar diversification.

Risk-free rates in 2023 were the highest in 15 years. The opportunity to lock-in elevated rates still exists and is particularly apparent in Europe where the ECB raised the Deposit rate aggressively last year, after a decade of zero or negative rates (2012-2021). The market expects the ECB to cut rates to 2.5% by the end of 2024 from 4% currently. If the ECB (and the other major central banks for that matter) will deliver anything close to what the market is pricing, the most important call to action is lock-in these elevated yields while they last and mitigate re-investment risk on your cash. We see value in adding short duration (1-5 year) to benefit from the roll down to maturity and also suggest to keep the long duration positions in your portfolio as a hedge to other asset classes in a risk-off environment. A risk to our view is a scenario in which inflation picks up again, such that central banks have to re-enter the fight to tame inflation with additional tightening, which could lead to a rates selloff initially and potentially tipping the economy into a recession later down the road.

From a credit valuation perspective, while EUR IG spreads have traded inside USD IG for most of the past decade, that relationship reversed with the onset of the Ukraine war and currently EUR IG is trading at a spread ratio to US IG not seen since the 2012 sovereign crisis.

Finally, we see a rare investment opportunity in the UK Gilts space for UK residents taxpayers.

Read more about what to expect from the Bank of England: https://privatebank.jpmorgan.com/eur/en/o/tmt/could-the-bank-of-england-hit-it-for-6-percent

How can fixed income fit into my portfolio

For investors, reinvestment risk is rising as cash yields are likely to go down this year. For those still overweight cash it’s time to extend duration. Historically, cash underperforms longer tenor fixed income after the last rate hike of a business cycle. For those still underweight duration these yields are still attractive. However, the late 2023 rate rally likely makes adding duration a carry investment (rather than a total return investment). For tactical investors, the front end of the curve may offer more relative value.

This is part of our monthly Global Investment Strategy (GIS) available to all our clients. It covers all the main markets and provides technical insight from our market solutions team reach out to the J.P. Morgan team to find out more.

What is Fixed Income:

Fixed Income is an asset class that is a commonly held investment because it helps preserve capital and provide a return through fixed periodic interest payments and the eventual return of principal at maturity. Fixed-income investments, or bonds as they are commonly known, typically provide a premium above inflation and experience less return volatility compared with shares. There are risks when investing in fixed income due to the unpredictability of the market, which can impact the market value. Interest rate risk is the biggest risk for fixed-income, but there are other things to be aware of including: call risk, credit risk, reinvestment risk and downgrade risk.

What are Investment Grade (IG) bonds

Investment grade (IG) bonds have a high-quality rating that signals a municipal or corporate bond presents a relatively low risk of default. S&P classifies “AAA” and “AA” (high credit quality) and “A and “BBB”” (medium credit quality) as investment grade. Moody’s classifies investment grade bonds as BAA or higher.

¹ The Standard and Poor’s 500 Index is a capitalization-weighted index of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% of available market capitalization

² The US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

³ The EUR IG Index is a market-weighted index of euro denominated investment-grade fixed-income securities excluding euro zone treasury and euro zone government related securities, with maturities greater than one year.