Surging inflation, rising rates, coronavirus threats and flattening curves make things challenging for bond investors in 2022. However, credit research on trends and the outlook for fixed income is critical. Investors must continue differentiating between sectors, securities and regions to survive in this type of environment. In this note, we explore the complex fixed income landscape in 2022 and suggest strategies to mitigate risks.
Yield curves expected to flatten
As markets started reopening in 2021, pent-up demand during the lockdowns led to strong economic growth. Developed markets began growing faster than they did before the pandemic. This above-average economic growth is expected to continue in 2022, but may slow by year-end.
Central bankers across the globe believe the pandemic will probably increase inflation and decrease economic growth. As a response to higher inflation, central banks are adopting tighter policies. However, the policies are not uniform; they differ based on each country’s challenges due to inflation. While the US Federal Reserve accelerated its QE tapering and indicated rate hikes, some central banks in developed markets had already hiked their rates. Japan is an exception, due to low inflation there.
As 2022 progresses, tighter policies are likely to slow global growth. Credit research indicates flattening yield curves that demand caution when taking risks.
Fixed income strategies to follow in 2022
Differentiate between sectors: Most importantly, investors must differentiate between sectors since today’s trends may not affect all risk assets to the same degree. Some sectors may perform sooner or later than others in the current market scenario. For instance, local-currency emerging-market debt (EMD) has the lowest returns currently, but it may be good for the future. At present, hard-currency EMD corporate and sovereign bonds seem more appealing.
Maintain credit exposure: As a high-yield investor, one should appreciate rising rates due to improved performance during inflation cycles. They result in strong corporate and consumer balance sheets, causing resilience in corporate issuers. For EM corporations in their expansion and recovery phases, the most significant risks are not defaults or downgrades but acquisitions and mergers.
Get tactical: Give attention to interest rates and portfolio sensitivity and duration when investing. Move slowly when yields are lower and accelerate when they rise. However, do not reduce exposure sharply since it may cause a shortage in both inflation and income-generating assets and bonds. Although growing assets are painful for the time being, they yield good results for investors over time.
Plan your move: Investors should start looking outside their domestic market for more opportunities and portfolio diversification. The multi-sector investment approach is best suited for the current evolving landscape. Investors must closely monitor valuations and conditions and plan the move as conditions necessitate. A more effective strategy is to pair growth-oriented credit assets with high-interest assets such as government bonds.
These strategies would help managers manage risks and make informed decisions, based on the circumstances. The right balance would generate potential returns and income while mitigating possible risks.
Key credit research takeaways
In the context of politics, monetary policy, fiscal policy and the pandemic, these fixed income strategies for 2022 would tilt the portfolio towards credit risk exposure. The following are the primary convictions to take away:
- Maintain a positive outlook for investment-grade credit and below-investment-grade leveraged credit in developed markets
- Seek to generate asset selection from divergent opportunities and risks, particularly in pandemic-impacted businesses
- Trade longer-end government yield curve segments with the objective of maintaining the range. They may migrate up exponentially while showing volatile transient periods
Foresee longer-term trends and outlook
While the abovementioned strategies present short-term challenges to bond investors, they may benefit over the long term. The three most important trends to check in 2022 are China’s impact on the global economy, bond-investing technological advancements, and environmental, social and governance (ESG) sectors. ESG has emerged as a significant investor concern, with investors now wanting to contribute towards ESG-linked structures and green bonds.
Although 2022 is expected to bring challenges, thoughtful adjustments and preparing for inflation can position your portfolio to benefit. With expert credit research in the field, bond managers and investors can mitigate uncertainties and be prepared for flattening yield curves.