Senior Portfolio Manager Todd Schomberg, from the Invesco Fixed Income (IFI) team, shares the team’s global outlook for inflation, growth, and interest rates, and where they expect to see opportunities in fixed income markets in 2022.
Global bonds in the not so “new normal”
As we look towards 2022, we’ve been reading a lot about the “new normal.” Well, in our view, 2022 will be anything but normal. After nearly 20 months of unprecedented support from governments and central banks, the band-aids are coming off and it’s time for the market and economies to go at it alone.
We expect the pace of global growth to slightly slow down to the 3 to 4% range. North America will likely continue to lead, while Europe and China could face more near-term challenges. The current elevated inflation levels will likely begin to subside in the second half of 2022, as central banks remove liquidity from the system and supply chains come back online. As we turn to corporate earnings, we anticipate the current tailwinds to global growth will help keep corporate earnings strong and balance sheets to continue to improve.
When all these factors are combined — slowing albeit positive global growth, healthy corporate earnings, slowing inflation, range bound interest rates, and higher yields than we’ve seen in nearly two years — it creates a stable backdrop for fixed income in 2022 amidst choppier markets, in our view. We anticipate the long end of the interest rate curve to be relatively anchored and range bound, while front end rates drift higher. We believe the best opportunities will be in investment grade credit across both North America and Europe, high credit quality Emerging Market countries, and BB-rated high yield securities.
Central banks on the move
Central banks have been having a stare down with the highest levels of inflation since the 1970s, and central banks are blinking first.
The U.S. Federal Reserve (Fed) is tapering its bond buying program by $30 billion USD per month,1 and we expect it will hike interest rates two to three times in 2022. Similarly, The Bank of England recently hiked interest rates by 15 bps,2 and The Bank of Canada highlighted the possibility of near-term interest rate hikes. Both are likely to follow through on hikes in early 2022. In Canada, the economy has recovered quickly, and the current excessive stimulative policies will likely be tightened.
As central banks turn their attention towards inflation, the reaction function of these central bankers has changed with the focus on price stability. This change has the potential for an uptick in central bank induced market volatility. Despite short term bouts of market volatility, central banks have worked too hard since the pandemic to let it all unravel on policy missteps. As a result, central banks are likely to remain cautious as they remove accommodation with the possibility of pauses on negative market reactions. Any central bank induced market volatility could potentially create a safe haven bid for global government bonds, helping to create a ballast in your portfolio.
Similarly, the Bank of Canada is expected to begin raising rates in the first quarter of 2022, but it’s unlikely it will match the fast pace of rate hikes currently priced in the markets. Other developed markets are likely to remain in a more accommodative stance with the European Central Bank (ECB) and Bank of Japan maintaining more stimulative policies. This cautious pace of rate hikes should continue to help provide a backstop for high quality fixed income assets as growth and inflation begin to slow in the second half of 2022.
Potential opportunities in 2022
Against this backdrop of global monetary policy normalization, we believe there will be several compelling opportunities:
- We think investment grade credit remains a sweet spot, as corporate earnings remain robust and investor demand is strong in both the U.S. and Canada. In particular, we anticipate the energy sector could continue to benefit from rising oil prices and oil companies repaying debt.
- We think European credit could provide pockets of opportunity, as Europe remains in the earlier part of the credit cycle with continued ECB support.
- We continue to favour BB-rated high yield credit across Canada and the U.S., as we anticipate continued credit rating agency upgrades in 2022 that will likely result in bond price appreciation within this space.
- Within emerging markets, we favour higher credit quality regions such as the Middle East and Latin America. We think there will be opportunities in areas that will benefit from a continuing rise in oil prices. We’re also seeing select value in Chinese debt issuers that have been unduly beaten up by the dislocation in the country’s property market.
- Away from credit, we’re finding good value in non-qualified mortgage-backed securities backed by the U.S. housing market.
- Lastly, we anticipate the Canadian dollar will be supported by the country’s growing external trade balance and higher interest rates. We will continue to hedge foreign currency risk to limit volatility.
The fixed income market may experience short-term dislocations in 2022, as central banks remove accommodation and/or new virus variants arrive. We think these dislocations will provide opportunities for active managers, and we’ll look to opportunistically take advantage of these dislocations. While we will look to take advantage of market volatility, we’ll also seek to continue to position our funds to remain a ballast in your portfolio, as we navigate choppy waters to the “new normal.”
- Source: Federal Reserve press release, Federal Reserve, Dec. 15, 2021
- Source: BOE Says ‘More Persistent’ Inflation Prompted Surprise Rate Rise, Bloomberg, Dec. 16, 2021