Weekly View from the Desk
Debt-Ceiling Scars and Shifting Probabilities
Volatility may increase as the Fed takes action, but today’s markets are creating opportunities for active managers
For bond investors, 2022 has been challenging. Inflation reached 40-year highs, the commodity bull market went into overdrive and Russia’s invasion of Ukraine created a reshuffling of the world order. Amid the uncertainty, bonds lost ground—the Bloomberg U.S. Aggregate Bond Index fell nearly 10% through mid May.1
What’s next for fixed income markets? Greg Peters, managing director and co-chief investment officer of PGIM Fixed Income, says there is good news and bad news. “I think volatility will continue to rise in the near term,” he says. “But, as the rate-hike cycle progresses, much of the uncertainty will recede. At that point, I think the volatility in bonds will recede as well.”
The Fed raised its target Fed Funds rate by 50 basis points at its May meeting and indicated it may target a rate as high as 3.30% by mid-2023. The Fed is reacting to high inflation, but its aggressive policies could trigger a recession. “They deal with inflation indirectly, basically slowing down the economy and getting unemployment up,” Peters says. “But that indirect mechanism creates a high risk for error.”
It may be months before the volatility in bonds begins to subside, but recent market action has created pockets of value that could benefit active managers. Peters is seeing compelling valuations among high yield bonds. “We’re seeing real dislocations that could create a rising tide for active management,” Peters says. “In three to six months, rates may have crested at a much higher level, and that’s when bonds may really help your portfolio.”
PGIM Fixed Income discusses four key findings about the U.S. yield curve.
If investor's objective is to accumulate future savings, rather than manage asset volatility, their portfolios should be constructed accordingly.
[1] https://www.wsj.com/market-data/bonds/benchmarks?mod=md_bond_view_tracking_bond_full
This video is for informational and educational purposes only and should not be construed as investment advice or an offer or solicitation in respect to any products or services. Investing involves risk, including possible loss of principal. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Past performance does not guarantee future results. Asset allocation and/or diversification do not assure a profit or protect against a loss in declining markets.
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