Fixed Income Market Review

Market review

Bond markets retreated sharply to finish the year after the Bank of Japan surprised markets with the timing of its yield curve control widening, lifting Japanese bond yields across the maturity spectrum. The move had a knock-on effect to other global markets as Japanese investors are a huge part of the ecosystem and will now require additional yield to maintain global investment programs in favour of domestic investments. Australian bonds over-reacted to this unexpected shift and underperformed most global bond markets on expectations of Japanese repatriation of foreign bond holdings. This action from the Bank of Japan should not be misconstrued as a major monetary policy pivot, the decision was also made with the intention of soothing the Japanese bond market from future bouts of volatility.?

Later in the month, news of China reopening also added to the bearish momentum in fixed income markets and combined with Christmas liquidity, the markets continued to leak to higher yields. The re-opening of China to the world is expected to give a boost to global consumption and the tourism industry and incited fears of further inflationary pressures resurfacing in 2023, when US CPI was showing signs of peaking as displayed by the second consecutive downside miss that was recorded for the November CPI earlier in the month.?

A turbulent year ahead

Looking forward as the cycle develops over 2023, economies and consumer spending should slow markedly, with headline inflation collapsing (barring exogenous geopolitical shocks) from the double digit outcomes seen in the US and Europe. This should not be confused with lower prices; high prices are here to stay in many goods and services, but the rate of change within these prices changes can move to zero (stable but high prices) therefore crushing inflation outcomes. This might suggest that Central Bankers can ‘pivot’, moving to a period of market accommodation which would allow much of the above recalibration to be avoided. That is a slim possibility, it likely requires a more peaceful 2023 with a resolution to the Russian/Ukrainian conflict which would be most welcome and a catalyst for a possible new bullish market phase. A more likely scenario is that rates remain at more normalised levels as markets move away from negative interest rates and Quantitative Easing, holding the interest rate structure at higher levels. This is an exciting development for active bond managers with a richer opportunity set on offer in that environment.?

The scope of these moves in December was a fitting finale for a challenging investment year in 2022 and was heightened by poor risk appetite into year end. This presents a significant medium-term opportunity to establish high quality and liquid fixed income positions for portfolios ahead of an expected turbulent 2023, where economies will slow and credit concerns will rise significantly.

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