Central banks and inflation key to bringing investors back into fixed income markets

Investing

The key to restoring the traditional inverse correlation of stocks and bonds is a reversal of both high inflation and high inflation expectations, says Ken Leech, chief investment officer at Western Asset.
Credit spread sectors are now extremely attractive, but macro risk remains elevated. | Image source: Getty Images

Western Asset, a global fixed income investment manager and part of the Franklin Templeton group, says credit spread sectors are now extremely attractive, but macro risk remains elevated.

Ken Leech, chief investment officer at Western Asset notes on the inverse correlation of stocks and bonds: “The key to restoring the traditional inverse correlation of stocks and bonds is a reversal of both high inflation and high inflation expectations. Once they start to decline, and there’s a downward momentum then we would expect to see the correlation between equities and fixed income go back to being negatively correlated.

“Of course, the other essential component is central bank tightening. So, if we can get to these peak rates where central banks become comfortable that they’ve got policy in a restrictive enough stance that they can stand pat, that also would once again provide the opportunity for investors to come back into the fixed-income markets.”

Leech adds: “Inflation has proceeded faster and for longer than we anticipated, and the damage to fixed income investment has been commensurate. However, we believe a falling-inflation scenario is still at play—one that would provide some comfort and respite to bond investors.

Ken Leech, chief investment officer at Western Asset | Image source: Supplied

“Whether you focus on demand and supply as the driver of prices, or on interest rates, or on the money stock as a measure of Fed policy, all of these indicators point to a substantial moderation of inflation in the near future. Furthermore, looking at economic conditions “on the ground” today, pricing in the goods and housing sectors is already moderating.

“Bond yields are also now at very attractive levels—the 10-year UST is at its highest rate since 2008. Given these factors and current market pricing, the priority for us over the next 12 months is to position portfolios to best maintain our current yield advantage relative to benchmarks.”


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