Potholes remain, but bonds headed in right direction Potholes remain, but bonds headed in right direction http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\traffic-cone-small.jpg January 17 2023 January 5 2023

Potholes remain, but bonds headed in right direction

Three things to watch in 2023.

Published January 5 2023
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Rocky road ahead With apologies to the beloved ice cream, we don’t see a way in which the Federal Reserve can pull off a soft landing. Not if it truly is committed to slaying inflation and retaining credibility it is capable of guiding the economy. Policymakers are reasonably confident they can achieve the former, but have deep concerns about the latter. There should be little doubt they are willing to risk a recession to accomplish both. That is probably unavoidable at this point, anyway. Whenever inflation has been above 4% and the unemployment rate has been below 5%, as both are now, a recession has followed within two years every single time. The same goes for every period in the past in which the unemployment rate has risen at least five-tenths of a percent. And the fact that the job market is refusing to turn over likely will push the Fed to keep a high terminal rate until it suppresses aggregate demand enough to weaken labor and regain price stability.

A yield curve you could ski down The inverted curve has already anticipated a slowdown. Unfortunately, the slope might transform from a green circle to a black diamond. We don’t think the bond market has priced in the magnitude of the coming contraction. Spreads are nowhere near the peak typical of recessions. At the very least, they should rise because Treasury yields historically drop in this type of economic environment.

Delay the credit play? We think so. Investors should resist the temptation to pounce on cheap bonds. Any sustained rally in stocks and corporate bonds likely is doomed because the Fed is apt to see it as a sign financial conditions are not tight enough, providing another reason to hold rates higher for longer. High-quality bonds and Treasuries are the best bets for the near future. But it’s not all bad news for fixed-income investors. We are headed in the right direction. The time to buy bonds and add back to the credit sectors is approaching.

Tags 2023 Outlook . Fixed Income . Markets/Economy . Inflation . Monetary Policy .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Yield Curve: Graph showing the comparative yields of securities in a particular class according to maturity. Securities on the long end of the yield curve have longer maturities.

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