PGIM Fixed Income Co-Chief Investment Officer, Gregory Peters, and Chief U.S. Economist, Tom Porcelli, recently shared their views on the market outlook.
Rates in strategic buy zone
Today’s elevated yields provide a favorable environment for bond investors.
Structural shifts have pushed rates higher in a durable way, reflecting more normalized conditions, unlike the very compressed rate cycles seen post-GFC, throughout and post-pandemic.
We think 10-year Treasury yields may hover between 3.8-5.0%, with no expectations to dip down to the territory in recent years.
This creates a favorable scenario for bond investors with attractive starting yields that provide a stronger outlook for forward-looking returns.
Bonds deliver when cheap relative to equities
From an asset allocation standpoint, we are in a much more balanced risk reward regime than before.
10-year U.S. bond yields currently exceed equity earning yields as measured by the S&P 500, making fixed income a more favorable option from a risk-adjusted return perspective.
Bonds have historically delivered an attractive Sharpe ratio when bond yields are higher than earnings yield, further supporting our bullish outlook for fixed income.
Also read: Inflation Surprises, But Markets Surprise More
Move in as central banks un-pause
Since 2022, developed markets rates have been rising steadily. Central banks have been on a pause in their hiking cycle, with some jurisdictions outside the U.S. beginning to ease rates.
Historically, bonds offer attractive risk-adjusted returns following central bank pauses. For instance, following Fed pauses, IG corporates returned ~8% p.a. comparable to U.S. stocks returns (~9%) on a 3-year basis – but with less than half of its volatility. Allocators can count on bonds again.
Investors now have the opportunity to lock in higher starting yields that are at levels not seen in a decade.
Going forward, we see bonds offering a greater total return profile, while being able to absorb shocks from equity market corrections. Cash yields are less sustainable in a slowing economic environment, given the scope for central banks to slash rates.
