Bonds are back

Bonds are back

Counterpoint - February 2023
Following one of the worst years in recent memory for fixed income markets, high-quality government bonds are rebounding and we believe they now offer decent returns for relatively low levels of risk

A new phase
The global economy should soon begin to recover from a difficult period of persistently high inflation and interest rate rises

Forecasting economic growth and inflation can be difficult. In particular, the persistence of last year’s price rises surprised many economists and the recent decline in inflation levels (while still high) has come sooner than some expected. The fall has largely been due to lower energy prices, which in Europe has been helped by a relatively mild winter. Meanwhile, while economic growth is slowing, we believe most regions should be able to avoid a deep or prolonged recession.

As I mentioned in our 2023 Outlook, this year is set to be one where bonds finally make a comeback and start providing diversification and returns in portfolios. Global fixed income markets have rebounded strongly from last year, spurred by a growing conviction that inflation has peaked on both sides of the Atlantic. The gains have been driven by a substantial rally in long-term government debt. With hopes that last year’s fixed income retreat is over, bonds are restoring their traditional reputation as a haven against economic uncertainty.

This shift is in stark contrast to the past decade when government bond yields were at record lows and some even turned negative. With low-risk assets offering such poor returns, the only way to find decent bonds yield in recent years was to turn to the riskier end of the fixed income market. However, following the recent rise in government bond yields, we no longer need to take that extra risk to earn a decent return.

Daniele Antonucci, Chief Economist & Macro Strategist

Top Chart
Moving in the right direction
While there may be some bumps in the road, we believe inflation is falling fast enough to allow the Fed to pause its rate hiking cycle this spring

US inflation is showing encouraging signs of moderation. 

The fall is largely driven by the unwinding of the pandemic-related factors, including lower demand for durable goods, and falling energy prices. 

Services demand is still strong on the back of a solid labour market, while the shelter component should improve soon. Even ‘sticky’ inflation (i.e., for goods/services that adjust prices infrequently) is beginning to roll over.

Source: In-house research, Refinitiv

Investment Focus
The cycle is turning
The global economy is likely to enter a new phase as it begins to recover around the second quarter of the year

What’s happening?

Although the global economy continues to slow, several factors have contributed to a more optimistic outlook for the global economy at the start of 2023. They include a sustained fall in US inflation, signs that inflation is peaking in Europe, the faster-than-expected reopening of China’s economy and a warmer-than-normal European winter. But risks remain and global economies are not yet out of the woods.

Central banks have hiked interest rates aggressively to slow economic activity and bring down inflation, and their policies seem to be working. The key question is whether the drag from these tighter financial conditions will cause a recession. We believe a recession is still likely in the UK and euro area, although perhaps less extreme than feared. The US, driven by the Fed, may also experience one but potentially milder given there are fewer imbalances than previous recessions: for example, household and corporate balance sheets are stronger while banks are better capitalised relatively to past recessions.

Following a recessionary environment at the start of the year, we expect a new economic cycle to take hold some time in the second quarter. Global growth should recover moderately, driven by China’s post-Covid rebound, peaking interest rates, slower inflation and fewer supply-chain strains. However, the war in Ukraine and any impact on energy prices are still key risks.

What we’re watching

In anticipation of the global economy entering a new phase of growth over the next few months, we have increased our exposure to high-quality government bonds, which offer attractive yields. Within equities, we’re keeping our slightly underweight position but believe a well-diversified equity mix can provide exposure to any renewed economic growth across both developed and emerging regions and we’re monitoring markets to ensure portfolios are appropriately positioned. 

We could increase our equity exposure if inflation, interest rates and bond yields fall more rapidly than expected, the Ukraine War ends, China reopens its economy even faster or company earnings prospects improve substantially.

Although some risks seem to have receded at the start of 2023, a number of events could also cause us to dial down risk further. They include a policy mistake by central bankers if they hike rates too far, as well as a possible inflation spike due to energy prices or higher wages. From a geopolitical perspective, any deterioration of the Ukraine War or the relationship between China and Taiwan could also be negative for markets.

With inflation falling (US) or tentatively peaking (Europe), several central banks are pivoting towards smaller rate hikes, to eventually stop hiking this spring
Valuation opportunities
We’ve adjusted portfolio allocations to reflect our outlook for the year ahead

Continuing with our theme that 2023 is the year that bonds are likely to make a comeback, we are looking to take advantage of the valuation resets in 2022. We have shifted our fixed income allocations away from higher-risk/lower-quality emerging market (EM) bonds – both local and corporate – towards safer developed market government debt. 

After years of low expected returns from safe bonds, we now expect them to provide a more meaningful long-term return to portfolios. This allocation allows us to achieve an attractive yield without the need to take on more credit risk, which is something that has been difficult in the negative-yielding world before 2022.

We are maintaining all our current tactical positions. Despite a more optimistic mood in markets during the final three months of 2022 and into the start of this year, we believe we are not out of the woods yet. In particular, we are focusing on gaining exposure to higher-quality fixed income assets such as US Treasuries and EU/UK investment grade bonds. We still favour EM equities and hard currency sovereign bonds, which should benefit from China reopening.

What to look out for
Geopolitical uncertainty is high, the pace of economic deterioration has slowed, US inflation is coming down and the Fed is raising rates in smaller increments.

What could make us increase or reduce risk?


Faster move past inflation/
Fed/bond yields peak


Increase equity/fixed income


negotiations/end of war


Increase EU equities/high-yield bonds


China reopening
without major problems


Increase EM/China risk exposure


Central banks overtighten
even if inflation slows


Reduce risk in equities & bonds,
add gold


Russia/Ukraine war
gets worse

Reduce European risk exposure,
add gold



Reduce EM/Asia
risk exposure


European gas crisis
deteriorates again


Reduce EU & UK
equities/high-yield bonds


Wage-price spiral
pushing inflation higher

Reduce bond exposure,
diversify further

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Information correct as at 6 February 2023.

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