Are you still sitting on the sidelines?

After a rally in late 2023, global bond markets have been relatively quiet this year. Faced with uncertainty around the timing and size of interest rate cuts, investors have taken a cautious view on timing the market. Today, in the US alone, over $US6 trillion is sitting on the sidelines in money market funds.

And while a cash-based investment strategy can be productive in times of rising interest rates, the inevitable easing of central bank policies means those clients sensitive to income returns may be looking for new strategies over the coming months.

For those clients who can see beyond the yield on very short-term assets, the fixed income market may provide an attractive entry point. Despite the slow start for bonds this year, fixed income is providing far greater yields than it has in years and will likely get a long-awaited boost when rate cuts eventually come.

Bond yields are no longer near the bottom of the barrel as they were in mid-2020, when the yield on the 10-year US Treasury was just over half a percent; today, at 4.5%, it’s more than seven times higher. Investors don’t have to stretch into higher-risk bond segments or hunt as intently for alternative yield sources to generate attractive income.

But timing is important because, historically, bond prices have started to rise ahead of a first rate cut. The investors who made the biggest gains were those who moved early (Display). Investors who stayed on the sidelines, waiting in cash deposits or money market funds until rates changed, missed out on the early gains.

After a period of rapid hikes, we are conscious that the next stage of the cycle will likely be a slowing of growth. Therefore, on a risk-adjusted basis, our view is that higher quality credit is a better place to allocate, particularly with higher starting yields providing the market a large buffer back to the breakeven point for investors on a total return basis.  

Investment grade bonds are issued by companies with strong balance sheets and high credit ratings (BBB- or higher by rating agencies like S&P, Moody’s and  Fitch’s). This high credit quality translates to a lower default risk compared to lower-rated, high-yield bonds. In uncertain economic times, the reliability of these issuers is a crucial consideration for risk-averse investors seeking steady income without the fear of significant capital loss.

The sector is well poised for when the interest rate cycle turns and duration starts to rally, providing return upside while not overly compromising on yield or credit quality.  Recently, demand for investment grade paper has been strong and increased issuance has been easily absorbed.

While predicting the moves of central banks is never easy of guaranteed, we have already seen the first rate cut by the ECB and the BoC, and there is the possibility of a rate cut this winter by the BoE and guidance from the Fed on the potential for rate cuts later this year.

Further to this, we believe that disinflation will continue throughout the developed world, since economic data released in May was largely consistent with that view. Labor markets are also showing needed signs of cooling, admittedly from very strong levels, giving central bankers some confidence that elevated interest rates are beginning to help lower wage growth. US inflation data showed a slight improvement compared with the first quarter, easing investor concerns about a rate hike by the Fed.

In this environment active management is key to successfully picking the winners and avoiding the losers. AB’s actively managed Dynamic Global Fixed Income Fund offers investors access to a broad range of debt securities and has strong exposure to investment grade credit, given the strong fundamentals and technical backdrop.

The Fund implements a global, multi-sector strategy, investing across corporate bonds, government bonds, asset-backed securities, mortgage-backed securities, closed-ended mutual funds and bank loans located anywhere in the world, including developed and emerging countries.

The fund added selectively to our investment- grade credit bucket in April. Selection remains key however, and we continue to have a preference on EUR investment-grade credit over their US counterparts on more attractive spread levels. We added several communication names in the month, with T-Mobile, AT&T and Cox Communications, as well as on the energy side with BG Energy Capital, Western Midstream and Total Energies. We also increased our consumer non- cyclical bucket. We also added some short-end fixed rate US investment- grade when yields moved above the cash rate, given the large sell-off in front end yields year-to-date.

Portfolio Analytics – AB Dynamic Global Fixed Income Fund May 2024

For more information on our Diversified Global Fixed Income Fund, please contact our team or visit the fund page.