Catherine REICHLIN: Without dwelling on the past, let us mention just one figure: the maximum loss between January and October 2022 of the Bloomberg Barclays Global Bond Aggregate Index reached -20%. This is four times the largest loss since the index was created in 1992. Looking at the glass as half full and looking forward, it also means that bonds are becoming attractive again not only for the income they offer but also for their diversification role, which is becoming meaningful again. Some investors buy bonds mainly for the income they generate. However, a drop in their price leaves no one unmoved, especially when it exceeds the income. And in 2022, the two main factors that impact bond prices - interest rates and risk premiums - have come under pressure. So the rise in bond yields creates new opportunities, but what about the factors that will affect their price in the year to come?
Marie THIBOUT: Global economic growth will slow below potential next year, driven by a combination of continued tight monetary policies and energy supply issues. The United States could avoid recession in 2023, given the good performance of employment. The recession in the Eurozone should remain limited in scope if the winter remains mild.
This slowdown in activity will help to reduce inflationary pressures in 2023. Indeed, US core inflation has begun to ease, and this should continue with the positive base effects on health services, as well as the expected stabilisation of the housing component after next summer. At the same time, inflation in the Eurozone recorded its first slowdown in November for a year and a half, and the core component is stabilising. Both the Federal Reserve and the ECB will therefore slow their pace of rate hikes and begin a pause in monetary tightening, likely as early as the second quarter of 2023.
This pause, together with the stabilisation of inflation expectations, makes the bond outlook attractive for 2023. Indeed, real sovereign bond yields have normalised in the developed world, returning to levels close to their long-term average.
Catherine REICHLIN: The US 10-year yield, both real and nominal, is back to levels not seen for over a decade. Thus we find the double attraction of bonds: offering an interesting level of income but also serving as insurance. This insurance makes sense in volatile times and can provide a comfortable safety cushion. For example, if the 10-year US Treasury yield falls from 3.5% to 2%, this represents an appreciation of the corresponding bond of almost 15%, a significant gain if other asset classes fall.
Marie THIBOUT: On the credit side, the risk/return trade-off is now also advantageous. The risk of credit spreads widening is contained, given the upcoming end of rate hikes, which limits the risk of recession in the United States.
Catherine REICHLIN: If we take the example of the risk premium on A-rated corporate bonds, it stands at 1.3% for a 10-year maturity, a record level since 2015. The majority of companies in this category have, moreover, taken advantage of the years of "cheap money" to rework their balance sheets and are now solid. To use the insurance and cushion analogy, this premium adds up to nearly 5% annual return on US sovereign debt. A bargain.
Marie THIBOUT: Finally, after their sharp decline since the beginning of the year, emerging market hard currency bonds are offering attractive yields, and credit spreads are above their long-term historical average. The pause in monetary tightening will ease the pressure on emerging assets, as will the gradual reopening of China, expected as early as next spring.
Catherine REICHLIN: In this more bond-friendly environment, gradually increasing exposure makes sense. Investment grade bonds and emerging market bonds are the first to be considered. Exposure to US sovereign bonds should not be forgotten and exposure to Eurozone bonds can start to be considered. An almost forgotten asset class, bonds are rising from the ashes and 2023 is looking bright.
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