Prices: will continue to fluctuate, and the US recession is mild

There are no serious tremors on the horizon for the US economy, which is instead resisting increasingly restrictive monetary policy and recent turmoil in the banking system. However, it is not excluded that the interest rate market may price in a crash during the year, in which case, there will be a deep recession in the United States with the Federal Reserve which will react by cutting rates before the end of 2023. But This scenario, as mentioned, is currently unimaginable. Andrew McCormick, head of global fixed income and chief investment officer for fixed income at T. Rowe Price, is convinced of this, predicting that the economic slowdown will be relatively mild. In that case, the Fed would remain on hold until December, with inflation still well above the 2% target.

The MOVE Index is at its highest level since the global crisis

However, the situation on this front is very volatile as a further increase in inflation data could be followed by further monetary tightening. On the other hand, there was still a lot of liquidity in the system and the demand for loans was low and declining. However, credit conditions are tightening. If demand for loans starts to pick up, tougher credit terms could limit companies’ access to financing and lead to a modest recession. In March, the expert recalls, the ICE BofA MOVE Index, which measures the volatility involved in US Treasury bond yields, reached its highest level since the global financial crisis, even surpassing the high level reached at the beginning of the pandemic in 2020. .

More time for the slope of the curve to return to normal

At the same time, the yield curve has suddenly become less inverted, with the 2- to 10-year Treasury yield falling from -106 basis points in early March to -39 points at the end of the month. It seems obvious, McCormick argues, that Traders were quickly adjusting their estimates of the extent of the recession and its impact on Fed policy. Although the index has moderated in the meantime, the price level and the shape of the yield curve are likely to remain volatile as this process continues. It can take up to 12 months for the inversion of the Treasury curve to dissipate, returning the curve to a more normal slope where short-term rates are lower than longer-mature yields.

Opportunity, but also caution in adding duration

How should an investor act in light of this somewhat volatile scenario? Is there any way to take advantage of a steepening yield curve? McCormick advises Caution in adding duration, as a lot of the short-term benefits of duration have already been priced into the price marketThanks to expectations of a deep recession. However, he adds, Positioning the slope of the 5- to 30-year segment of the US Treasury curve is an attractive opportunity, as the federal funds rate reached its highest point in the cycle. He also suggests some term exposure in their portfolios as he believes the historical negative correlation between bonds and equities will return this year.

That will come as a relief to investors who have been disappointed throughout 2022 by positive correlations between asset classes, when both fixed income and equities fell sharply due to rising inflation and the speed of the Fed’s tightening. Negative correlation can It will not be as strong as in the past, it must – according to McCormick – contribute to it Enhance the convenience of maintaining a fixed income allocation in a diversified portfolio.