Cautious hope for fixed income investors

Despite recent fluctuations in bond yields, fixed income investors can maintain cautious optimism.

After a sharp spike in October, bond yields have shown signs of stabilizing, said Jeff Mayberry, fixed income asset allocation strategist and portfolio manager with DoubleLine Group in Los Angeles.

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According to Mayberry, the surge in yields initially raised concerns that the issuance of Treasuries would drive interest rates higher. However, he said this unease has somewhat subsided due to a weaker employment report and a moderation in October inflation figures.

Given this backdrop, Mayberry said that, with the exception of the Bank of Japan, most major central banks are likely finished with interest rate hikes.

Rate cuts, however, are another story.

“It’ll be interesting to see when major central banks begin to cut rates,” Mayberry said. 

In the U.S., he said the market is pricing in the possibility of rate cuts in the first half of next year, but he thinks the timing hinges on various economic factors. According to Mayberry, the probability of rate cuts is inflated by concerns about a potential recession in early 2024.

However, he said the Fed’s primary focus remains on getting inflation back to its 2% goal, and he thinks it’s more likely that rates won’t come down until the second half of next year.

His outlook for fixed income is positive despite recent rate volatility. 

“That makes it a little bit harder to manage but also more fun to manage, because that means there’s more opportunities,” he said.

By taking on some credit risk, Mayberry said investors can earn attractive yields of around 9% in the high-yield market. However, he recommended a diversified approach, avoiding overexposure to specific asset classes, such as U.S. corporate credit or emerging market debt. 

Mayberry said investors should still allocate a portion of their portfolio to safer securities, such as U.S. Treasuries. He also advocated for shorter-duration strategies such as two-year Treasuries, which could act as a source of “dry powder.”

This diversified approach provides a buffer and allows investors to capitalize on opportunities during periods of flight to quality or economic downturns.

“We are kind of playing both sides of things,” he said. “Being able to pick up opportunities across the universe really provides a good future outlook for fixed income.”

Regarding the future of interest rates, Mayberry acknowledged the difficulty in making accurate predictions. He said that while a recession might trigger a reflexive rally in interest rates, the supply of Treasuries in the market could lead to a drop in rates. 

Mayberry anticipated that the 10-year yield might drop as low as 2.5%, but emphasized the possibility of further fluctuations, reinforcing the idea of “higher for longer” interest rates.

Regardless, one of the main concerns circulating in the fixed income market is the potential for a recession. Mayberry highlighted key indicators such as the yield curve and the unemployment rate, both of which suggest the possibility of a recession beginning in early to mid-2024. 

He said investors should keep an eye on credit spreads, as a widening of these spreads may serve as an early signal of an impending economic downturn.

“We’re in the mindset of early to mid next year, be aware there’s that potential recession out there,” he said. 

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