As advisors look to reposition portfolios for the new year, it’s important to consider the shifting outlook for fixed income investments.
Notably, flows have not aligned with best total returns, instead matching up with investor sentiment. Investors have largely remained defensive, a positioning that may cause portfolios to miss out on compelling returns.
“The market has really been in this state of sort of almost living in a world that very different from the from the truth and reality of the underlying economy. For almost two years now, we’ve been three months away from a recession,” Jason Bloom, Invesco’s head of fixed income and alternatives, ETF product strategy, said during VettaFi’s Market Outlook Symposium on December 14.
Bloom said this has begun to moderate as now the debate is whether the Fed will achieve a soft landing. The more optimistic outlook is pervading in the past couple of months, he said.
“The market has been perfectly wrong in predicting a Fed rate cut six months from now for the last two years. That trend has been incredible,” Bloom said.
In response, he is inclined to stay with this trend: If the market thinks the Fed is going to be cutting aggressively in 2024, he’s leaning toward a healthier economy than what is expected. This lines up with what the market has already been seeing, Bloom said, citing fewer rate cuts than were expected.
“At the end of the day, that’s really good news,” Bloom said. “I think what’s really changed just in the last month or two is the optimism around inflation. We’ve been getting some nice positive surprises there.”
How a Higher Inflation Environment Impacts the Fixed Income Outlook
If the U.S. economy does see core inflation promptly moving towards 2%, Bloom said his view is “2% is more the floor, whereas in the last decade, it was the ceiling”.
Going forward, he expects the economy won’t look as it did in the 2010 through 2019 timeframe. Instead, it may loo more like it did in the 1990s and early 2000s.
In a slower cut environment, Bloom said he would favor high yield. Currently, loans are yielding 9% and high-yield bonds are yielding over 8%.
“In a slow cut environment, that’s going to mean a strong economy, probably healthy credit spreads. That higher yield is going to outperform,” he said.
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