Home Industry Finance Insights: Why bonds are becoming investors’ favourite words Bond investors are presented with the opportunity to lock in one of the highest yields in more than ten years by Althea Spinozzi January 29, 2024 Image: Getty Images What will the combined global headwinds, such as weakening growth, declining inflation, and geopolitical tensions, herald for the market in 2024? Volatility is a given but here are some factors to keep an eye out for. While all eyes are on the central banks such as the US’s Fed and EU Central Bank and their expected rate cuts, it is unlikely that they will do so aggressively, leading to uncertainty in bond markets. Hence, investors should focus on high-quality sovereign bonds, while selective investment in corporate bonds could be considered. Weakening growth, inflation, and a shaky geopolitical environment Although sluggish growth and declining inflation have set the grounds for lower interest rates, monetary policy uncertainty and geopolitical tensions will remain which means that markets should be ready for another bumpy ride in 2024. The increase in policy rates from last year have helped cool down inflation but it has also brought forward the probability of a recession. This sentiment is shared across leading economists and bond futures priced prematurely could undergo a soon-to-come cutting cycle. However, central banks stuck to their “higher for longer” stance can upset markets later this year. Fast forward, and policy rates have risen to their highest level in more than fifteen years. Despite economic woes, policymakers are not expecting to cut rates aggressively in 2024. However, a recession in the US economy could quickly change this. A fragile geopolitical landscape will add to market volatility. The US is facing geopolitical tensions in Ukraine, Israel, and Taiwan. With the US going to the polls in November, the political situation will likely move to gridlock in 2024, lowering the fiscal impulse and adding to growth uncertainty. The above calls for caution from central banks when tightening the monetary rates further or easing it too quickly, implying higher volatility in bond markets. The bonds market offers attractive prospects for investors Bond investors are presented with the opportunity to lock in one of the highest yields in more than ten years. Higher yields do not only mean higher returns, but also a lower probability of bonds posting a negative return even if yields rise slightly again. With central banks likely to cut rates slowly, the lagged transmission of aggressive monetary policies from 2023 will continue to tighten financial conditions in the new year. This would favor extending duration and quality in the medium term. There are three possible scenarios for developed market sovereign bonds in 2024: Soft landing scenario: The battle against inflation is over, and a deep recession is avoided, causing central banks to cut rates slightly, but not aggressively. Yield curves would steepen, with 10-year yields adjusting moderately lower from where they are today. Hard landing scenario: a deep recession forces central banks to cut rates aggressively, provoking a deep bull steepening of yield curves. Rates would fall considerably across tenors. The 70s scenario: Inflation reignites, forcing central banks to hike again. This would see yield curves bear flattening, with front-term yields offering a considerable pickup over long-term yields. Quality is king Deteriorating economic activity and high rates do not bode well for risky assets, which could lead to higher corporate bond spreads amid slowing revenues and compressed margins. While yields on corporate bonds in the US and Europe have risen together with sovereign yields, the pickup that investment-grade corporate bonds offer over their benchmarks is well below the 2010-2020 average. When looking at junk, the picture is even more depressing. USD high yield bonds pay 260 basis points over comparable investment grade bonds, a level in line with pre-Covid valuations when the Fed was stimulating the economy through quantitative easing and interest rates were less than half what they are today. In Europe, junk pays 310 basis points over high-grade peers, reflecting a more challenging macroeconomic backdrop. Therefore, we see better value in developed market sovereigns, although a selective approach for corporate bonds remains compelling. The author – Althea Spinozzi, is head of Fixed Income Strategy at Saxo Bank. Tags Bonds finance Investments investors Saxo Bank You might also like Hoxton Wealth’s Chris Ball on the company’s rebranding and ambitious goals DIB issues $500m AT1 sukuk at 5.25% profit rate Saudi’s Cenomi Centers, GIB Capital unveil SAR1bn real estate fund Rawabi Holding, World Wide Generation new JV to drive sustainability