Is Fixed Income back in favour?

With many of the major developed market central banks expected to begin cutting interest rates this year, fixed income investments look set to be back in favour. In this article we explain why this is the case and the potentially attractive ways to access this asset class.

Between 2021 and 2022, inflation in the US, eurozone and UK rose sharply (see Chart 1). Consequently, the Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) all raised their policy interest rates to levels not seen since before the Global Financial Crisis to better balance supply and demand and help stem further increases in inflation.

On the back of the interest rate increases, yields on government bonds also increased. However, these yield increases were not consistent across different maturities, with short-term yields rising more than their longer dated equivalents meaning yield curves inverted (see Charts 2). In turn, this made cash deposit rates relatively more attractive as an investment option for investors seeking a fixed return in a diversified portfolio.

2023 and beyond

In 2023, inflation rates began to converge towards central banks’ targets. Subsequently, central banks stopped raising policy interest rates and began discussing how long they would need to be maintained at current levels. The Fed, ECB and BoE have all indicated that they will start to cut interest rates in 2024 (see Charts 3):

“If the economy evolves broadly as we expect, most FOMC participants see it as likely to be appropriate to begin lowering the policy rate at some point this year.” – Chairman Powell, Fed (3 April 2024)¹

"We are making good progress towards our inflation target. And we are more confident as a result. But we are not sufficiently confident, and we clearly need more evidence, more data. We will know a little more in April, but we will know a lot more in June.” – President Lagarde, ECB (7 March 2024)²

“The fact we have a curve that has cuts in it for the year as a whole is not unreasonable to me.” – Governor Bailey, BoE (22 March 2024)³

‘Markets expect the ECB to begin cutting interest rates in June, with the BoE following in August and the Fed in September’

What does this mean for investors?

As interest rates are lowered, yields are also expected to decline. And with the yield curve currently inverted, we believe that short duration yields, such as cash deposit rates, will fall by more than longer duration yields. This means that while cash deposit rates may currently offer a higher yield than longer-dated alternatives, there is a potential opportunity for investors to lock in higher yields for longer.

……a potential opportunity for investors to lock in higher yields for longer…...

¹https://www.federalreserve.gov/newsevents/speech/powell20240403a.htm

²https://www.ecb.europa.eu/press/pressconf/2024/html/ecb.is240307~314650bd5c.en.html

³https://www.ft.com/content/964d883f-4f47-4f2f-bd13-b44858efa075

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