Capital IdeasTM
Investment insights from Capital Group
Fixed Income
Flavio Carpenzano
Peter Becker
Our latest Ahead of the Curve paper examines opportunities for fixed income investors in what is likely to remain a positive environment for the asset class.
The underlying structural and cyclical resilience of the US has enabled it to avoid recession so far; unusually, economic data now points toward the economy returning to mid-cycle. Combined with a slower decline in inflation, this suggests the Federal Reserve (Fed) will continue to cut interest rates but not as fast or as much as the market initially anticipated.
Meanwhile, this relatively benign backdrop should be positive for risk assets in general; in other words, an environment where yields and spreads could remain range bound and rates relatively volatile. This would mean carry (income) rather than duration is likely to be the dominant component of fixed income results.
Our bias is currently towards higher-quality investment grade credit as we believe this area offers better relative value with spreads having tightened. The spread between A and BBB bonds, shown in the chart, is very tight on a historical basis, which means investors are receiving poor compensation for the additional credit risk taken when moving down in quality. An example of one of the higher-quality areas where we are finding opportunities is pharmaceuticals. Bonds within this traditionally defensive sector are currently available without sacrificing as much spread versus the broader market as has historically been the case.
Valuations favour higher-quality bonds
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Source: Barclays. Data based on Bloomberg indices. Data as at 30 October 2024
Relative value considerations also suggest a bias toward investment grade over high yield with spreads between the two close to the lowest levels for 20 years. That said, we believe the attractive level of yield offered, improved credit quality of the index and relatively short duration of US high yield provides a good source of diversified carry for mixed asset portfolios. Examples of opportunities our research has identified include names within the pharmaceutical and independent energy sectors.
Overall, fundamentals across corporate and emerging markets remain constructive, with the outlook supported by the recent shift in Fed policy. Valuations are tight relative to history, but given the positive outlook for economic growth, the carry component remains compelling with select opportunities in investment grade, high yield and emerging markets.
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Past results are not predictive of results in future periods. It is not possible to invest directly in an index, which is unmanaged. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.
Capital Group manages equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.