13 Mar 2023 4 min read

Avoiding crush depth: why we are optimistic about fixed income

By Colin Reedie

Apocalyptic forecasts seem to have abated and fixed income has had a positive first quarter. What are the variables that could determine returns for the rest of the year?


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It’s apocryphal that the old curse ‘May you live in interesting times,’ emerged from China. From an investment perspective, in early 2023, we think it may not even be a curse.

As we look toward the next few quarters, there are several market-moving questions that won’t remain questions for long. In short, we remain confident there will be lots for active managers to potentially take advantage of.

What questions do we see getting answered in the next few quarters?

  1. Will the labour market crack?
  2. Can any downturn be shallow?
  3. Will central banks ease as quickly as markets want them to?
  4. How much will inflation fall when unemployment rises?

We noted in a recent blog that we thought markets had at one point been too inclined toward doom. With labour market data stubbornly remaining robust and refusing to play along with the prevailing narrative, it has been difficult to become conclusively negative on growth. This difficulty was underlined by the US payrolls data for January, when the American economy unexpectedly created 517,000 jobs[1].

We’ve seen similar resilience in labour markets all around the developed world – including here in the UK, where in spite of universally gloomy economic forecasts, employers have continued to hire and hand out pay rises.


Goldilocks in a submarine

How central banks responds is key here.

We think it is more than possible for interest rates to go higher, but in our view any future hikes are unlikely to come fast enough to creative the negative returns in fixed income that bedevilled investors last year. 

We can think of the search for the ‘right’ interest rate (to create the fabled soft landing) as analogous to searching for the crushing depth in a submarine. We all know from submarine movies that once you cross the sub’s depth rating it’s wise to slow your descent.

Global policymakers appear to have concluded they have raised rates to the point where monetary policy is ‘tight’. We think policymakers do not wish to send the American economy to a watery grave, so we don’t think likely a sudden reacceleration from 25 bps (basis points) to 50 bps or higher.So, if there is a ceiling on the pace of rate hikes, this makes rates’ actual levels the key variable – in particular if we can identify one that they will struggle to break through.

Unfortunately, this is as difficult a question to answer as it gets, primarily because of the huge challenge in forming any substantive view around the distribution of inflation risks. This means in turn it is difficult to say at what level rates become ‘restrictive’.

Let’s illustrate this with an example: if we start with an interest rate of 5% and expectations for inflation move from 2% to 4%, then interest rates need to move to 7% to achieve the same level of real ‘tightness’.

However, when we look at real interest rates, a lot of the uncertainty around the distribution of inflation risks disappears, so we can – in theory – say something meaningful about what a ‘restrictive’ level is.


Why we are optimistic around fixed income

We are comfortable saying that in a modern, developed capitalist economy, it is hard for real rates to remain above real trend growth for an extended period. Real yields on 10-year US Treasuries are (at the time of writing) 1.5% – that’s within what we’d consider a plausible range of trend growth, and in response we’ve started adding duration with a longer-term view.

As said above, changing circumstances mean the challenging interest rate environment of 2022 is unlikely to recur. In fact, in our view there are multiple angles of opportunity for fixed income this year, and we believe all-in yields are offering attractive running returns. Our analysis suggests interest rates are now high enough that bonds could provide insurance value should a recession materialise.



[1] US Bureau of Labor Statistics, 3 February 2023

Colin Reedie

Head of Active Strategies

Colin has responsibility for our Active Strategies team as well as overall portfolio management responsibilities for our Global Credit and Core Plus strategies. Colin joined LGIM in 2005 from Henderson Global Investors, where he was Head of Investment Grade Credit Fund Management. He has 25 years’ experience in bond markets, specialising in non-government debt, and he has previously worked for Henderson Global Investors, Scottish Widows and Scottish Amicable.

Colin Reedie