Market expectations excessive; but caution warranted – Steve Ellis, Global CIO Fixed Income, Fidelity International

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The market narrative has continued to evolve over the summer, and investors are putting more onus on the challenges to growth. The Fed’s dovish tone at its FOMC meeting added more fuel to rising bond prices, with the 10-year treasury yield compressing by 47 basis points in July from its peak.

Against this backdrop, Steve Ellis, Global CIO Fixed Income, Fidelity International, provides his outlook for the bond market and why the team maintains their bias towards duration and a defensive stance in investment grade.

“Bond markets have moderated their expectations of tightening, and the terminal rate has come down in recent months from 4% to 3.25-3.5%. Markets expect falling rates in the second half of next year.

“As a result, some of the value in duration that we have highlighted recently has been realised but there could be more available still. Inflation is elevated, so we do not rule out additional tightening, however, markets expect another 100 basis points of hiking this year and this is, in our opinion, excessive.

“Data continues to deteriorate, and the headwinds to growth are building; a slowdown that tips the US economy into an official recession is a distinct possibility this year. Those risks are heightened in Europe given the worsening position of consumers.

“Credit spreads could widen further as expectations for defaults in a recessionary environment rise. Our calculations continue to indicate that US high yield spreads are under-pricing the risk of recession, despite spreads widening over the past two months. There is more room for adjustment, and with the ongoing risks to growth, we maintain our bias towards duration in treasuries and European sovereigns and a defensive posture in investment grade.”

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