Fixed income investment manager, Western Asset, part of Franklin Templeton, has updated their outlook for global bonds as inflation continues its downward trend and many central banks approach the end of their tightening cycles.
Robert Abad, Product Specialist at Western Asset says, “Looking ahead six to 12 months, we think the stage is set for global bonds to outperform.
“First, the most opportune time to invest in a country’s fixed-income market is when its interest-rate cycle is stabilising or poised to decline. These outcomes are already playing out across a number of emerging markets (EM) and are about to materialise over the next few months in key developed markets (DM) such as the US, Europe, the UK and Australia. Global government bonds are increasingly pricing in these outcomes especially as incoming economic data suggests weaker growth and inflation could surprise to the downside.
“Second, it’s important to factor in the direction of the US dollar (USD). Last year, the USD surged higher mostly on the back of the Fed’s aggressive rate-hiking campaign. Since the USD’s peak last September, improving global growth prospects and a narrowing interest-rate differential have pushed the USD lower. We see a possibility that the dollar moves sideways from here in the short term, but we expect it to depreciate somewhat over the longer term as the global economy and sentiment rebound. In periods of extended USD weakness, non-US assets have tended to perform well.
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“Third, we need to factor in valuations. Global bond yields surged last year due to the sharp rise in global inflation and the aggressive rate-hiking campaign by central banks. Yields, in some markets, moved even higher in recent months on the back of idiosyncratic risks: for example, in September 2022, yields of UK government bonds (gilts) spiked due to mini-budget concerns; in December 2022, Japanese government bonds (JGBs) were roiled by the Bank of Japan’s (BoJ) surprise adjustment to its yield curve control (YCC) framework; and in March/April 2023, short-dated US Treasuries (USTs) exhibited unprecedented volatility due to regional bank turbulence and fears of a possible US default due to the debt ceiling standoff.
“Each of these episodes offered asset managers such as Western Asset an opportunity to add value for investors by capitalising on these market dislocations.
“In Australia we remain tactical in the 10- and 20-year parts of the curve on further Reserve Bank of Australia (RBA) action,” says Abad.
“Based on our view of a weaker USD over the longer term, we are anticipating a stronger AUD.
“We expect the global economic downturn brought about by sharply tightened and concerted monetary policy will eventually lead to stronger risk appetite as markets begin to look past the malaise. In this case, the AUD will be a likely beneficiary while the Australian economy is expected to outperform due to the more cautious approach taken by the Reserve Bank of Australia on tightening,” he adds.
Abad says that now is the time to be active in global bond investing.
“It’s important to bear in mind that economic cycles, fiscal policies and central bank policies don’t move in tandem. There’s substantial variance among the change and movement of absolute yield levels, slopes and shapes of government bond curves, both within and across countries.
“For example, in the EM world, the Central Bank of Mexico has paused its rate hikes while the Central Bank of Brazil looks poised to make its first rate cut. In the DM world, the Fed looks like it’s nearing the end of its hiking cycle while the BoJ might look to continue tweaking its current set of policy tools further to push rates higher. To complicate matters, market participants are constantly trying to identify catalysts that might influence the drivers and direction of each of these markets, which can sometimes generate bouts of volatility.
“What all of this means is that investors need to be very thoughtful about which countries to own and where duration is held along that country’s yield curve.
“We believe the most effective way to accomplish this—while at the same time trying to navigate through periods of volatility—is by embracing an active approach to global bond investing.”
