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Lisa Kailai Han
2022-12-26T10:30:00Z
- As equities plunge and recessionary fears grow, bond yields look increasingly enticing.
- Priya Misra continues to believe the 10-year US Treasury remains an excellent store of value.
- She also recommends offseting front-end bonds with high-yielding mortgage-backed securities.
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Over the past few years, assets like energy stocks, cryptocurrencies, and real estate have clamored for their turn in the spotlight. Now it's time for another passing of the torch — but this time to the bond market.
During the years of easy money leading up to 2022, bond yields struggled to entice investors, with the 10-year US Treasury yield rarely climbing above 2.5% in the last decade. But as the equity market continues to get pummeled by rising interest rates and falling earnings margins — with no end in sight — bonds have suddenly begun to look much more appealing.
"Fixed income starts to look attractive if recession risks are growing," said Priya Misra, head of global rates strategy at TD Securities, in a recent interview with Insider. "Through the course of the next year, we are more positive and constructive on fixed income."
Timing is everything when it comes to the bond market, since it's important to lock in higher interest rates before the Federal Reserve begins cutting them again. As for how high the central bank will hike interest rates this time around, Misra is more on the hawkish side, predicting a terminal rate of around 5.5% due to stickier inflation.
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Misra also believes that the stock versus bond dichotomy will continue to grow in 2023. "In general, we are negative on equities as an asset class, at least at the start of the year," she added.
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Misra believes that investors are best served by adopting a barbell strategy, buying both the front and back end of the yield curve.
After years of yielding almost zero, front-end bonds and cash are now earning their keep by helping investors mitigate opportunity costs. "You have dry powder; you can invest it when different markets price in recessions," Misra explained. "I think having liquidity is key so that you're not forced to sell in a state where the markets are not super liquid and nobody wants the asset; you'll end up selling at worse levels."
To offset these more liquid assets, Misra recommended investors look to pick up yield, such as with mortgage-backed securities, which she said look attractive at their current spreads. There's also no credit risk to these types of assets, since they're guaranteed by government-backed agencies such as Fannie Mae and Freddie Mac.
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Inflation-linked bonds also stole headlines this year, and Misra said that they'll continue to be a good buy going forward, especially since she believes inflation will remain at around 3% by the end of 2023. But Misra definitely prefers longer-end bonds for their stability in the face of an economic slowdown, and continues to believe that the 10-year US Treasury will be the best store of valuefor investors over the next decade.
"Over time as inflation comes down and the Fed eases, I would say the 10-year's better than the very front end because I think duration risk is attractive when the economy slows down," she explained. However, Misra believes that the current 10-year Treasury yield of around 3.7% feels a little too low, especially since she forecasts rates climbing slightly higher in the near future.
On the other hand, Misra isn't particularly a fan of investment-grade or high-yield corporate bonds in the backdrop of falling earnings. "Investors may want to demand more spread for buying corporate bonds in an environment where growth is slowing and it's not clear which corporate can handle the rise in interest rates easier," she explained. While investment-grade bonds have less default risk, Misra believes investors may find it hard to pick and choose winning sectors within a high-interest-rate economy.
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