Fixed income looks promising again with recession worries

As the risk of recession rises, investors should not shy away from bonds, says a CIBC portfolio manager.

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Markets saw two competing narratives this summer: central banks will tame high inflation and engineer a “soft landing,” or they will be too aggressive and push the economy into a recession.  

“We’ve seen these two themes battle for dominance, and it has caused significant volatility in the bond market,” said Adam Ditkofsky, portfolio manager and vice-president at CIBC Asset Management.

The yield curve has already inverted in the U.S., with shorter-dated bonds seeing higher yields than longer-dated bonds, and Ditkofsky said it’s possible the U.S. is already in a recession. 

So what does that mean for bonds?

Last year, Ditkofsky said the concept of TINA or “there is no alternative” dominated the market, with both stocks and bonds  looking expensive. 

However, since the beginning of 2022, bond yields have moved higher, with 10-year Treasury bonds sitting above 3% compared to around 1% in September of last year, making them more attractive. 

“We’d argue that bonds look a lot more compelling today than where they have been for a long time,” he said. 

With the risk of a recession, Ditkofksy said the 60/40 portfolio is more important than ever “and investors should not be avoiding bonds.”

In a recessionary environment, corporate bonds are typically harder hit than government bonds. That said, some high-quality investment-grade corporate bonds are now yielding between 4.5% and 5%. 

Further, Ditkofsky said economic weakness could be a sign that central banks’ hiking cycle may be coming to an end, which could be supportive for credit spreads. 

In terms of risk, Ditkofsky said to expect more volatility as the inflation and recession themes continue to battle for dominance. 

Regardless, he predicts economic growth to slow below 1% for both Canada and the U.S. over the next 12 months and he expects yields to modestly fall. And while he said inflation will remain elevated, it should come down from its current levels as well. 

Ditkofsky sees opportunities in government bonds at their current levels, as well as high-quality, short-term investment-grade corporate bonds because they are less sensitive to changes in interest rates.

“Overall, we’d argue that bonds are more compelling than they’ve been for a very long time,” he said.

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