No Easy Path for the Fed
As we look ahead to 2023, the Federal Reserve (Fed) has the challenging task of trying to combat inflation without causing a hard economic landing. While the market is excited about the recent pullback in monthly CPI data, it’s important to remember that, historically, inflationary events have lasted a long time, going through several peaks and troughs. In addition, government debt is very high and continues to grow, and the cure for inflation (tighter policy) is “kryptonite” to an overleveraged economy. Accordingly, the Fed faces a very challenging market backdrop as we head into the new year (3:37).
Higher Yields Here to Stay
For bond investors, the good news about this market backdrop is that higher yields are here to stay. Carry has come back to the fixed income market, leading current income to play a more significant role in bond returns (7:06). For example, at current yields, the income earned on the current 10-year Treasury note provides a return buffer even if rates continue to rise next year. For high yield, the carry is even higher by historical standards, and as a result, we are seeing increased demand for high yield strategies (13:44).
All in all, the market outlook for bonds is positive. Interest rate normalization has returned us to a world where carry is a meaningful component of return, where duration, credit and liquidity risk are priced more appropriately, and where a far greater range of scenarios can lead to positive returns. Looking ahead to 2023, we believe the role of fixed income in diversified portfolios will be as important as ever as correlations also return to normal in the absence of quantitative easing.
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Originally published by VanEck on 5 December, 2022.
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