Fixed income, it's time to reset portfolios
According to Gregory Peters, co-ceo at PGIM Fixed Income, the Fed may cut after the Ecb. But high rates are here to stay and will create a goldilocks scenario favorable to bonds. Real estate and banks are going to be the best performers
by Giulio Zangrandi
In spite of expectations, the Federal Reserve has hit the mark. Indeed, the idea to fight inflation without sinking the Us economy has not remained on paper as many expected. And now, on the opposite, it opens the door to a goldilocks scenario that sees fixed income poised to take off after two years of underperformance. According to Gregory Peters, co-chief investment officer at PGIM Fixed Income, the season of “no cost of money” is now behind us and bonds are preparing to offer high yields without a rate risk.
Fed more hawkish than ECB. But timing will be crucial
Since the resilience of the new regime depends mostly on the stickiness of inflation, the starting point of Peters' analysis was the definition of the 2024 macro perspectives. An activity that results in different scenarios between the two opposite sides of the Atlantic Ocean. In the United States, the expert illustrated, “labor demand is falling but upward pressure on wages (particularly in the service sector) will continue to be fueled by low unemployment rates”. This factor, coupled with a recession outlook downgraded to just 25%, leads him to expect the Fed to postpone rate cuts or implement them to a lesser extent than expected. Not to mention the hawkish boost that could come from the wars in Ukraine and the Red Sea or the consequences on GDP of a possible shutdown if the outgoing President does not have the majority to refinance the government budget.
As for Europe, the asset manager’s baseline scenario foresees a rate cut of 50 basis points by Q4 2024. In the big picture, a plateau in the cost of money is still seen as the ideal time to buy debt securities. “As central banks around the world begin to cut rates, we should expect even more investors to reduce their exposure to equities or cash and return to a more traditional portfolio allocation," Peters explained, by emphasizing that this action requires to move early in order to avoid the resulting drop in yields.
Real estate and banks in the spotlight
Regarding asset allocation, the Cio points out that segments with excellent values during 2023 now appear to be 'squeezed' and less attractive: these are, in particular, leverage loan securities but also investment-grade and high-yield. This does not mean, however, that a good selection cannot still find interesting opportunities in these areas as well. What is attracting the AM's attention is the market of commercial real estate mortgage-backed securities (Cmbs). “Concerns persist about the future of office spaces in a world where more and more people are working from home but the asset class is trading at an attractive discount and the worst predictions of permanent damage to the commercial market seem exaggerated”, Peters said. But another area that he trusts is banks: “Deposit outflows have stabilized and credit groups should receive more stability from Basel III Endgame, a new set of rules that will increase capital buffers for larger players”.
The ‘emerging’ rebus
Considering the geographic dimension, Peters sees significant tailwinds for emerging markets: “They were the first to raise rates in response to inflation and they will likely be the first to cut them”. Factors that should favor the category include the competition between U.S. and China for hegemony in the Global South, the shift in supply chains away from Beijing, the growth of foreign direct investment in other areas and the increased demand for commodities to build new green technologies or infrastructure. The Cio concludes: “Investors should look at countries like Indonesia or India and Mexico, which are growing rapidly and directly thank to changes in the global supply chains”.