Fixed income markets "should surprise on the upside in 2016", according to a forecast by asset manager PGIM Fixed Income.
Chief investment strategist Robert Tipp described 2015 as "the typical 'one step back' year that will find its way between the equally numerous 'two step forward' years where fixed income delivers solidly positive returns."
Writing in the Prudential Fixed Income 1st Quarter Outlook report, Tipp said the firm's optimism derives from a combination of its "low and range-bound" rates hypothesis and its belief that the "spread sectors" – non-government bonds – offer great value.
In an economic backdrop of moderate growth, below-target inflation, low rates and quantitative easing, Tipp expects long-term rates in Germany, Japan and the US to remain below their 2015 highs for some time to come.
This means fixed income products should outperform cash in the intermediate to long run, via a "yield and curve roll down" strategy alone (which involves buying a bond with a maturity in the higher yielding section of the yield curve, and selling the bond prior to maturity when it reaches a lower yielding section.)
Tipp is also optimistic about the spread sectors, even if leverage in the world's economies is high and creating increased downside risk. Spreads widened everywhere through 2015, even in places away from credit hotspots (see chart below). This left spreads at a substantial premium to fair value, Tipp wrote.
He also believes that policy should continue to support risk-taking this year. Policy makers were busy in 2015 trying to promote growth, keep markets calm, get inflation to target, and this will continue through 2016. This will also support spread sectors.
Tipp highlighted the parallels between now and the end of 2013's Fed-induced 'taper tantrum,' as rates in the US have risen, spreads have widened and retail investors have been selling their mutual fund shares. This results in favourable fixed income valuations, "with rates at the top of their recent ranges and spreads at multi-year wides in many cases."
The report was put together by PGIM Fixed Income, known in the US as Prudential Fixed Income. With around $565bn in assets under management, it is part of PGIM, the global investment management arm of US-headquartered Prudential Financial.
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