Navigating Rates

Four fixed income themes to watch

Many of the major central banks (excluding Japan) are beginning or set to begin interest rate-cutting cycles this year. Here are four fixed income themes we believe could present investors with opportunities during the remainder of 2024.

Key takeaways

  • In anticipation of future rate cuts, we favour steepeners in the US and Germany, while monetary policy normalisation in Japan over the coming years favours a flattening yield curve expression.
  • Following a high degree of correlation in the performance of developed bond markets, diverging economic outlooks will likely open up relative value opportunities across sovereign bond markets.
  • Caution is warranted in corporate bonds – especially high yield – given rich valuations.
  • As economic performance and monetary policy diverge, and the US dollar starts to face headwinds, active currency management is set to play an increased role in fixed income portfolios.
Favour yield curve relative opportunities

In the last decade, declining economic growth expectations, low inflation and quantitative easing saw government bond yield curves flatten in the major G4 (ex-Japan) markets; the yield on longer maturity bonds was little more than that on shorter maturity bonds.

While the economic environment has shifted considerably in recent years, with rising inflation and sharply higher interest rates, the US Treasury curve (among others) remains remarkably flat relative to history (see Exhibit 1) as the persistent outperformance of the US economy has kept upward pressure on front-end yields.

However, we expect the US and German yield curves to re-steepen over the remainder of 2024. Despite volatile macro data making the timing of rate cuts more uncertain, we still expect central banks to deliver cuts in 2024 and this could be a catalyst for a re-pricing of front-end yields. In addition, the world is transitioning from a disinflationary macro landscape, with very loose monetary policy and fiscal restraint to one with greater inflation risks, more conventional monetary policy and greater fiscal activism in response to climate change, ageing populations and rising geopolitical risks. As a consequence, we expect the “term premium”– the extra yield investors demand for holding longer maturity bonds over shorter ones – to rise, weighing on ultra-long maturity bonds.

US and German yield curve steepening trades should benefit in this environment. In particular, we look for a steepening between 7-year and 30-year US Treasuries, coupled with a steepening in German Bunds between 5-year and 30-year and 10-year and 30-year maturities.

In Japan, however, we expect policy interest rates to be normalised over the coming years in the face of rising inflation expectations. The Bank of Japan’s balance sheet is amongst the largest of the G10 markets and the bank owns a larger share of its government bond market relative to its peers, with its Japanese government bond (JGB) holdings concentrated in sub-10 year maturities. Any adjustment of its balance sheet has important implications for the JGB market. Japan currently has the steepest 7s30s curve among the G4 markets and eventual policy normalisation should drive a flattening in the JGB curve.

Exhibit 1: Yield curve opportunities: flat vs steep curves.

US 5s30s and Japan 7s30s yield curves, basis points

Exhibit 1: Yield curve opportunities: flat vs steep curves

Source: AllianzGI, Bloomberg, 31 May 2024

Diverging economies suggest relative value opportunities

As Exhibit 2 shows, major developed government bond markets have behaved virtually in lockstep in recent years.

However, opportunities now abound as economic trajectories are set to diverge thanks to growing differences across countries and regions in terms of debt fundamentals, the transmission of monetary policy and the ability of governments to boost their economies with fiscal support.

This could mean attractive returns from relative value positions going forward. As an example, the strength of US economic data has led to a dramatic shift in expectations for 2024 rate cuts, with markets now pricing in just over one rate cut this year versus six back in January.1 By contrast, UK macro fundamentals (sub-trend growth and fiscal restraint) and an attractive valuation backdrop given restrictive real rates, favours an allocation to UK Gilts on a cross-market basis.

Exhibit 2: High correlation between major government bond markets

Mean 1-year rolling correlation of major developed market government bond markets vs US Treasuries

Exhibit 2: High correlation between major government bond markets

Source: AllianzGI, Bloomberg, 31 May 2024

Keep a cautious credit stance, particularly in high yield

Credit spreads – the risk premium offered by corporate bonds over sovereigns – are looking increasingly expensive versus long-term ranges (see Exhibit 3).

From a macro perspective, hopes of multiple rate cuts in 2024 from the US Federal Reserve and other central banks have faded, even as inflation worries have receded somewhat; consequently, real interest rates have risen and are beginning to put corporate fundamentals under more pressure, especially for high yield issuers.

In addition, there are early signs that corporate pricing power is beginning to weaken as some key engines of US consumer spending lose steam. This makes us wary about adding exposure to credit at this time.

Nonetheless, we are cognisant that history shows that credit spreads may not materially cheapen for some time in the absence of a negative catalyst, such as renewed Fed rate hikes or much weaker US growth prospects.

In the short term, therefore, we see a case for staying invested in investment grade corporate bonds for the attractive “carry” – the income gains made from holding bonds over time – favouring relative value opportunities in financials over industrials. Greater caution, however, is warranted for high yield bonds. When we do see a material widening in credit spreads, this could present an opportunity to add back credit exposure.

Exhibit 3: Corporate bond spreads close to recent lows

Bloomberg Global Agg Corporate Index option-adjusted spread (in basis points)

Exhibit 3: Corporate bond spreads close to recent lows

Source: AllianzGI, Bloomberg, 31 May 2024

Active currency management to play increasing role

One longer-term dynamic we believe fixed income investors need to watch is the potential for active currency management.

As Exhibit 4 shows, FX markets are currently experiencing a period of relative calm. We expect this to change as economic performance and monetary policy diverge across the major economies.

One of the biggest reasons we haven’t seen this play out yet is the US dollar which, thanks to relative US economic strength and its role in the global monetary system, continues to hover around four-decade highs in real trade-weighted terms. Going forward, we believe that cyclical and structural factors should begin to weigh on the performance of the US dollar. This is the case both over the near term, as US growth outperformance fades versus other major markets, and over the medium term, as US industrial and trade policy objectives erode the “strong US dollar” policy.

We therefore expect active currency management to begin making a larger contribution to returns for fixed income portfolios, especially in the coming months if volatility rises on the back of policy uncertainty as we head towards the US elections in November.

Exhibit 4: Currency calm should subside

Basket of EURUSD, USDJPY, AUDUSD and USDMXN volatilities

Exhibit 4: Currency calm should subside

Source: AllianzGI, Bloomberg, 4 June 2024

1 Bloomberg data, 4 June 2024.

  • Disclaimer
    Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

    The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is for Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations and is for information purpose only. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of this document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced, except for the case of explicit permission by Allianz Global Investors. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional /professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.

    This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; Allianz Global Investors UK Limited, authorized and regulated by the Financial Conduct Authority; in HK, by Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; in Singapore, by Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; in Japan, by Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424], Member of Japan Investment Advisers Association, the Investment Trust Association, Japan and Type II Financial Instruments Firms Association; in Taiwan, by Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan; and in Indonesia, by PT. Allianz Global Investors Asset Management Indonesia licensed by Indonesia Financial Services Authority (OJK).

    3640096

Explore Insights

Navigating Rates

With all signs pointing to a Donald Trump win, we expect many of his populist policies to cause ripples, even though markets were largely priced for this outcome. How might investors navigate the election result?

DISCOVER MORE

Navigating Rates

The US Federal Reserve’s policy pivot has ushered in a new investment regime that should help provide a near-term floor for risk sentiment

Read More

Navigating Rates

Going into the year, 2024 was always set to be an intense election period, with polls in more than 60 countries. It turned out to be even more action-packed than anticipated, with snap elections in France and Japan giving investors even more to focus on, in addition to the US election. What are the implications of one of the busiest years in election history? We asked our global CIOs how investors could position themselves in a shifting political terrain.

Read More

Allianz Global Investors

You are now leaving the Allianz Global Investors’ website and being redirected to

Welcome to the Allianz Global Investors website dedicated to the United Kingdom

Select Role
  • Adviser & Wealth Manager
  • Individual Investor
  • Institutional Investor
  • You have connected to this site as a “Professional” as defined by MiFID.  To continue, you must have the experience and knowledge required in investment management, particularly regarding the risks involved in accessing this site.

    If you are not a “Professional” client, we invite you to leave this page and reconnect on the “Individuals” page from the Allianz Global Investors website.

    US persons: The information shown on this site is not intended for US citizens, US nationals, or to those US persons such as defined by “Regulation S” of the Securities and Exchange Commission under the Security Act of 1933.

    This site is only intended to provide information on Allianz Global Investors and the products authorised for marketing in the UK.  The information presented on this site does not constitute an offer to sell or subscribe to a financial instrument.

    The views and opinions expressed herein, which are subject to change without notice, are those of the issuer companies at the time of publication. Your access is subject to the UK regulation and to the legal terms and general conditions of access to this site.

    In choosing to access our site, you acknowledge that you understand and accept these conditions.  We advise, for your best interest, to read these conditions carefully.

    Please read the following page carefully before proceeding as it contains important information concerning your use of the website and explains certain legal and regulatory restrictions applicable to any investment in Allianz Global Investors investment products. By pressing ‘Accept’ you agree that you have read and understood the following information.

    The material on this site is directed only at persons in the UK and does not constitute an offer or invitation to buy or sell the funds to persons in any jurisdiction other than the UK.

    Allianz Global Investors (AllianzGI) has taken reasonable care to ensure the accuracy of information available through the site. However, the information may be amended at any time by AllianzGI without notice. As far as it is permitted under the Financial Services and Markets Act 2000, AllianzGI does not accept liability for any loss, direct or indirect, owing to reliance on any information contained herein.

    Opinions expressed whether in general or both on the performance of individual funds and in a wider economic context represent the views of the contributor at the time of preparation. They are subject to change and should not be interpreted as investment advice which AllianzGI is not authorised to give.

    This site may provide links to third party websites over which AllianzGI has no control. These links are provided for your convenience and AllianzGI accepts no responsibility for the content of such websites.

    For your security we may record or randomly monitor all telephone calls.

    A word of warning
    Past performance does not predict future returns. The value of investments and the income from them can go down as well as up and an investor may not get back the amount invested. 

    Exchange rate fluctuations may vary causing the value of overseas investments to go down or up. For your own security any calls may be recorded and randomly monitored.

    For information on any specific risks associated with our funds and products please see our Key Investor Information Documents (KIIDs) and Supplementary Information Documents (SIDs).

    The use of this website is subject to English Law and any dispute will fall under the jurisdiction of the English courts.

    Regulation and Status Disclosure
    Allianz Global Investors represents products and services of Allianz Global Investors UK Limited, www.allianzglobalinvestors.co.uk. Allianz Global Investors UK Limited is an investment company, incorporated in the United Kingdom, with its registered office at 199 Bishopsgate, London, EC2M 3TY. 

    Allianz Global Investors UK Limited, company number 11516839, is authorised and regulated by the Financial Conduct Authority. Details about the extent of our regulation are available from us on request and on the Financial Conduct Authority’s website (www.fca.org.uk). The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted; except for the case of explicit permission by Allianz Global Investors UK Limited.

    Throughout the website Allianz Global Investors UK Limited may sometimes be referred to as Allianz Global Investors or AllianzGI.

    Copyright
    Copyright in this website is owned by Allianz Global Investors UK Limited. The copyrights of third parties are reserved.

    You may download or print a hard copy of individual pages and/or sections of the website, provided that you do not remove any copyright or other proprietary notices. Any downloading or other copying from the website will not transfer title to any software or material to you.

    You may not reproduce (in whole or part), transmit (by electronic means or otherwise), modify, link or use for any public or commercial purpose the website without the prior permission of Allianz Global Investors.

    Cookies
    Allianz Global Investors UK Limited uses session cookies for the purpose of saving data relating to the management of a user session in the memory of the web browser on the user’s computer. By cookie it is meant the small text file that is stored on the hard disk of a computer by the web browser on the said computer. Such file contains information sent by the web server of the Website that a user has visited. The information derived from session cookies enables Allianz Global Investors UK Limited to identify which areas of the Website are seemingly of more interest to users so that it can improve the Website and the information provided to users. The data which is stored via session cookies does not include any private information regarding the user, and is erased as soon as the browser is shut down. It is to be noted that most web browsers are set up in such a way that they automatically accept cookies. Users can, however, amend the configuration of the web browser on their computers so that they are systematically notified of any instance where the Websites that they are about to visit contain cookies.

Please check the checkbox to accept the terms and conditions.