Stabilising interest rates set stage for bonds

Yasmine Raso

Senior Journalist, Financial Newswire

16 August 2023

Global bonds are poised for outperformance amid inflation’s global cooldown and the slowdown of central banks’ tightening cycles, according to Western Asset.

Product Specialist, Robert Abad, said interest rates in several emerging markets (EM) have either stabilized or prepared for decline, with a similar outlook for developed markets (DM) such as the US, Europe, the UK and Australia presenting an “opportune time” to invest in fixed income.

“Global government bonds are increasingly pricing in these outcomes especially as incoming economic data suggests weaker growth and inflation could surprise to the downside,” he said.

“It’s important to factor in the direction of the US dollar (USD). Last year, the USD surged higher mostly on the back of the Fed’s aggressive rate-hiking campaign. Since the USD’s peak last September, improving global growth prospects and a narrowing interest-rate differential have pushed the USD lower.

“We see a possibility that the dollar moves sideways from here in the short term, but we expect it to depreciate somewhat over the longer term as the global economy and sentiment rebound. In periods of extended USD weakness, non-US assets have tended to perform well.”

Abad highlighted how several occurrences led to “market dislocations” that added value for investors, such as UK government bonds spiking due to budget concerns in 2022, Japanese government bonds agitating after the Bank of Japan’s surprise adjustment to its yield curve control (YCC) framework, and short-dated US treasuries (USTs) experiencing volatility after the US debt ceiling disagreement and potential default.

“We expect the global economic downturn brought about by sharply tightened and concerted monetary policy will eventually lead to stronger risk appetite as markets begin to look past the malaise,” he said.

“In this case, the AUD will be a likely beneficiary while the Australian economy is expected to outperform due to the more cautious approach taken by the Reserve Bank of Australia on tightening.

“It’s important to bear in mind that economic cycles, fiscal policies and central bank policies don’t move in tandem. There’s substantial variance among the change and movement of absolute yield levels, slopes and shapes of government bond curves, both within and across countries.

Abad recommended investors take on an active approach when it comes to investing in global bonds to better equip themselves when navigating inevitable periods of volatility.

“Investors need to be very thoughtful about which countries to own and where duration is held along that country’s yield curve.”