The second half of 2023 should see the onset of one of the most telegraphed recessions in history. Our central case remains that the recession will be mild as both the consumer and corporate sectors have relatively strong balance sheets. There is bifurcation between those consumers with excess savings and those struggling due to cuts in real wages. Similarly, we expect greater dispersion in the outcomes for businesses as 14 years of ultra loose monetary policy has come to an end.
It is likely that the US Federal Reserve has reached peak interest rates for this cycle, with a high hurdle for the data to beat to persuade the Fed to start hiking rates again. Given the Fed’s dependence on data, investors will be watching the data releases even more closely than usual, with the potential for markets to over react to economic surprises. The market is already pricing in US rate cuts later this year, even though there are some aspects of the data, particularly core inflation and employment, where we haven’t seen a significant impact from the high interest rates yet. There is now a strong central case that the European Central Bank (ECB) will raise rates by two more 25bps increments to reach a terminal rate of 3.75%; similarly to the Fed, it would take a big shift in economic data to deter it from this path.
In recent data releases, we have seen a modest deterioration in economic data, and we expect this to continue as the year progresses and we start to see more of an impact from interest rate hikes, so we have increased the duration of our strategic bond strategies. Presently we have 6.25 years exposure (US 2.25 years, UK 2 years, Europe 1.5 years and New Zealand 0.5 years) in strategic portfolios and we would look to add another 0.25 years soon if some of the flight-to-quality premium due to the US regional bank difficulties comes back out of bond prices.
Credit spreads, the additional yield above the comparative sovereign bonds, have tightened since their recent zenith in October 2022. Credit spreads, as well as the total yield available in corporate bonds, are attractive for long-term investors but we do expect market volatility to create buying opportunities later in 2023.
We currently have exposure to investment grade and high yield bonds of 50% and 20% respectively in our strategic portfolios, levels that we deem to be neutral. The aforementioned volatility, caused by the impending recession, US debt ceiling drama, or an unknown unknown, is viewed as a time when we would look to increase our aggregate credit exposure. At the individual issuer level, we have recently been participating in high quality BB-rated high yield new issues which are offering very attractive coupons i.e. yields, as we observe the ‘re-couponing’ of the high yield market.
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Key Risks
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies which may have the effect of increasing volatility. Some of the Funds may invest in derivatives. The use of derivatives may create leverage or gearing. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead.
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