Though the new year began with a wide range of issues, the lack of market consensus is creating a robust array of opportunities for active fixed-income investors.
Current market pricing indicates a short, but sharp, tightening cycle, i.e., up to 8 interest rate increases during next 12 months – the market is pricing this outcome for the moment.
Opportunity #1: Grade Corporate Bonds
Among corporate bonds with a relatively low risk of default, we see the most return potential in financials, which could benefit from interest-rate hikes. Financial companies also have the potential to adjust to higher inflation risks relative to other sectors in the market.
Opportunity #2: High-Yield Bonds in Specific Sectors
Absolute spread levels in high-yield bonds are close to being fully valued, yet relative valuations across sectors are reasonable. Given the present conditions, we would prefer durations of up to three years for high-yield debt because it is less interest-rate sensitive versus the broad index.
The best opportunities can be found in:
- Energy, should prices move higher
- Cable/media/broadcasting, though, expect volatility in the near term and seek opportunities to buy at attractive valuations
- Retail, because of strong consumer fundamentals
- Building materials, as demand for and prices of real assets may increase
Opportunity #3: Securitized Credit as a Short-Duration Play
Securitized credit will remain compelling, too, as a short-duration asset class with respectable yields and solid credit fundamentals. Housing in both the U.S. and Europe remains well-supported by price appreciation of the underlying assets and the credit quality of borrowers. We are wary, however, of commercial real estate, but this varies greatly by sector. Agency mortgage-backed securities may also lose a tailwind from Fed purchases and cheapen in 2022.
Opportunity #4: Emerging-Market Debt and Currencies
After lagging in 2021, emerging-market debt has a lot of room for improvement this year. Central banks in emerging markets have been well ahead of developed markets in raising rates to stem inflation risks. If inflation stabilizes as we expect in 2022, then both local emerging-market debt and currencies stand to appreciate as global investors become attracted to the yield and carry potential returns from this asset class.