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Inflation and labour markets have remained stubborn for some time, causing many major central banks to delay the start of their monetary easing cycles. However, there are signs that these key measures are beginning to ease, which paves the way for fixed income markets to deliver attractive risk-adjusted returns. We believe a strategy with an active approach to investing across the global fixed income spectrum is best placed to capitalise on the opportunities that could emerge as the tide turns for the asset class.
Is it too late to invest in fixed income?
It is a natural concern for investors to think they’ve missed the fixed income train given how far credit spreads have compressed already. Spreads are at multi-year tights, and there feels like little room for them to compress any further.
However, while spreads may offer less upside potential, all-in yields across nearly all major fixed income sectors remain well above 2022 yields. Therefore, investors still have time to lock in these yields as central banks embark on their cutting cycles.
It was also promising to see correlations between government bonds and equities have now moved to neutral or negative, having previously been positive in the high inflation environment. Bonds once again offer investors diversification, which is particularly important in a multi-asset context should equities encounter volatility going forward.
Yields across the fixed income market are above 2022 levels
Fixed income yields, %
Source: Bloomberg, ICE BofA, J.P. Morgan Economic Research, LSEG Datastream, J.P. Morgan Asset Management. Return correlation to MSCI ACWI is calculated using monthly total returns since 2008. Indices used are as follows: Euro IG: Bloomberg Euro-Aggregate –Corporate; Global IG: Bloomberg Global Aggregate –Corporate; UK IG: Bloomberg Sterling Aggregate –Corporate; US IG: Bloomberg US Aggregate –Corporate; Convertible bonds: Bloomberg Global Convertible Rate Sensitive hedged to USD; Euro HY: ICE BofA Euro Developed Markets Non-Financial High Yield Constrained Index; Global HY: ICE BofA Global High Yield Index; US HY: ICE BofA US High Yield Constrained Index; EMD corporate: CEMBI Broad Diversified; EMD local: GBI-EM Global Diversified; EMD local –China: J.P. Morgan GBI-EM Broad Diversified China; EMD sovereign: EMBI Global Diversified; EMD sov. IG: EMBI Global Diversified IG; EMD sov. HY: EMBI Global Diversified HY. Past performance is not a reliable indicator of current and future results. Guide to the Markets - UK. Data as of 23 September 2024.
The high current yield levels are especially important given starting yields are historically a strong predictor for future annualised returns over the following five years. The current yield-to-worst on the Bloomberg Global Aggregate Total Return Index of nearly 4% implies over a 4-8% annualised return in the subsequent five years. Income-seeking investors now have an alternative source of yield in core fixed income as money market yields decline.
Starting yields are an important indicator of future returns
Global fixed income yields and subsequent returns
%, subsequent return is % change annualised
Source: Bloomberg, J.P. Morgan Asset Management. Index used is the Bloomberg Global Aggregate index. Past performance is not a reliable indicator of current and future results. Guide to the Markets - UK. Data as of 23 September 2024.
So what about spreads?
There is no escaping the fact that spreads are not cheap. A resilient consumer and strong corporate balance sheets have meant that investment grade and high yield spreads continued to grind tighter to levels not seen since 2021. However, given our base case scenario for the US economy is a soft landing, historical analysis suggests that credit spreads can tighten further from here. From both the top-down and bottom-up, we are seeing reassuring signs that credit markets remain healthy, which supports being overweight versus our benchmark.
In a soft landing, spreads can stay tight for a long time
Source: Bloomberg Barclays; Spread Data uses US IG Corporate Index daily data. *Takes the current index composition (maturity and quality) and applies it to 1990s spread levels. OAS: Option Adjusted Spread. Data as of 28 October 2024.
Positioning for a soft landing scenario
We continue to see attractive opportunities across the global fixed income landscape. We believe a strategy with an active approach to investing across the global fixed income spectrum is best placed to exploit risks and opportunities as we enter what could be an exciting period for fixed income investors.
Our JPM Global Aggregate Bond Active UCITS ETF – an active core bond allocation launched in October 2023 – we believe is positioned to capture two key macroeconomic themes that we think will play out in the coming months: an interest rate cutting cycle by most major central banks, and a soft landing for economic growth. This means the portfolio has a diversified basket of curve steepeners as well as sectors that offer greater carry, such as investment grade credit, mortgage backed securities and European peripheral debt.
As central banks cut rates in a soft landing scenario, we can expect the curve to steepen further as front-end yields decline. We think an effective way of capturing this move is via steepeners. The steepener trade also acts as a recessionary hedge to the riskier parts of the portfolio should a recession occur. In this scenario, the Federal Reserve’s cutting cycle will need to be more aggressive than currently priced, and the curve can steepen by an even greater extent.
Within credit markets, we continue to favour overweight positions in investment grade assets. Although investment grade spreads are relatively compressed, all-in yields remain above longer-term averages.
From a technical perspective, supply and demand in primary issuance markets has been strong, providing further support to the asset class. Meanwhile, from the bottom-up, corporate earnings also continue to look robust. A strong fundamental and technical backdrop means that we continue to think spreads can grind tighter going forward, while current yields provide an attractive entry point for investors looking to increase their investment grade exposure.
However, the portfolio remains well poised for a multitude of scenarios. Our barbell approach to holding credit risk as well as curve steepeners means that if a soft landing isn’t realised, our risks are diversified and we can hedge against the possibility of a recession. So the JPM Global Aggregate Bond Active UCITS ETF1 is well positioned we feel to benefit from a soft landing scenario, with the added protection of curve steepeners should we enter a recessionary environment.
1 The objective of the Sub-Fund is to achieve a long-term return in excess of Bloomberg Global Aggregate Index Total Return USD Unhedged ("the Benchmark") by actively investing primarily in a portfolio of investment grade debt securities, globally, using financial derivative instruments to gain exposure to underlying assets, where appropriate.
Risk profile:
The value of your investment may fall as well as rise and you may get back less than you originally invested. The value of debt securities may change significantly depending on economic and interest rate conditions as well as the credit worthiness of the issuer. Issuers of debt securities may fail to meet payment obligations or the credit rating of debt securities may be downgraded. These risks are typically increased for below investment grade debt securities which may also be subject to higher volatility and lower liquidity than investment grade debt securities. The credit worthiness of unrated debt securities is not measured by reference to an independent credit rating agency. Emerging markets may be subject to increased political, regulatory and economic instability, less developed custody and settlement practices, poor transparency and greater financial risks. Emerging market currencies may be subject to volatile price movements. Emerging market securities may also be subject to higher volatility and lower liquidity than developed market securities respectively. Investments in onshore debt securities issued within the PRC through Bond Connect are subject to regulatory change and operational constraints which may result in increased counterparty risk. Market volatility and potential lack of liquidity due to low trading volumes may cause prices of bonds to fluctuate significantly. To the extent that the Sub-Fund uses financial derivative instruments, the risk profile and the volatility of the Sub-Fund may increase. Convertibles Convertible securities have characteristics of both debt and equity securities and carry credit, default, equity, interest rate, liquidity and market risks. Convertible bonds may also be subject to lower liquidity than the underlying equity securities. Contingent Convertible Securities are likely to be adversely impacted should specific trigger events occur (as specified in the contract terms of the issuing company). This may be as a result of the security converting to equities at a discounted share price, the value of the security being written down, temporarily or permanently, and/or coupon payments ceasing or being deferred. Asset-backed and mortgage-backed securities may be highly illiquid, subject to adverse changes to interest rates and to the risk that the payment obligations relating to the underlying asset are not met. Since the instruments held by the Sub- Fund may be denominated in currencies other than the Base Currency, the Sub-Fund may be affected unfavourably by exchange control regulations or fluctuations in currency rates. For this reason, changes in currency exchange rates can affect the value of the Sub-Fund's portfolio and may impact the value of the Shares. Exclusion of companies that do not meet certain ESG criteria from the Sub-Fund's investment universe may cause the Sub-Fund to perform differently compared to similar funds that do not have such a policy. The Sub-Fund seeks to provide a return above the Benchmark; however the Sub-Fund may underperform the Benchmark.
Risk Indicator:
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