CONTRIBUTORS
Christy Tan
Investment Strategist
Franklin Templeton Institute
Lukasz Labedzki, CFA
Senior Analyst
Franklin Templeton Institute
Key takeaways:
- Resilience in yields: Despite recent market shifts, yields remain attractive to fixed income investors. This paper delves into key and thematic questions, concluding that many risks are already factored into market prices, providing a solid buffer for those investing with a long-term perspective.
- Geopolitical risks and rate cuts: Rising geopolitical tensions could delay the anticipated rate cuts. However, these same risks underscore the vital role of fixed income investments as stabilizers within investment portfolios, enhancing their value during volatile times.
- European rate outlook and challenges: While the pathway to rate cuts appears more straightforward in Europe, the high hedging costs could dampen investors’ enthusiasm for EUR-denominated bonds.
Second quarter (Q2) 2024 highlights
In Q2 2024, the conviction-based Franklin Templeton Institute’s US Fixed Income Navigator (FIN) moderated, bringing us back into upper bound of neutral territory. We assess the balance of risks and opportunities that underpins the current reading.
Exhibit 1: Fixed Income Navigator Dashboard
March 2024 Update
Source: Franklin Templeton Institute.
Undeniably, yields are still attractive in the fixed income space, nearing the highest levels in more than a decade. Market pricing is now more conservative, and that effectively reduces the risk of abrupt repricing. Risk-reward profiles for high-quality intermediate bonds are in favor of taking some interest-rate risk, especially for buy and hold investors. Increasing geopolitical instability can trigger some “flight to safety,” resulting in a greater appetite for Treasuries.
From the risks perspective, the Federal Reserve (Fed) might keep rates higher for longer amid the relative strength of the US economy and growing concerns about inflation. As a result, the market may be pricing in higher terminal rates. Another risk is the increased supply of coupon bonds with less demand at current prices. More importantly, an escalation of geopolitical risks (especially in the Middle East) can lead to another inflationary impulse.
In this paper, we explore some key and thematic questions that are relevant to fixed income investors.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility.