Outlook 2023: the bond market's revenge?
- 15 December 2022
The global bond market in 2022 will be remembered for being as challenging as it was in 1994: a year marked by a massive and unexpected readjustment of interest rates. Inflationary pressures fueled by geopolitical conflicts and imbalances between supply and demand led central banks to tighten their monetary policies abruptly and raise key rates. The pace of the rate hikes was so fast, never before seen in the history of financial markets, that all asset classes were impacted. In September particularly, we saw a bond crash in the UK and extremely high volatility.
Given this market context and a difficult year, we believe that the outlook for 2023 is starting to brighten. Firstly, the absolute level of yields is at its highest, which adds to the attractiveness of the bond market. Secondly, the central banks’ bull market cycle seems to be mostly behind us. And finally, the rebound in performance observed at the end of 2022 is helping to restore investor confidence.
Investment Grade strategies to be favoured
The credit market seems attractive, especially for investment grade, where the risk/return ratio has improved significantly over the past year. Indeed, yields are around 4% in the Eurozone and 5.5% in the US[1] while the average duration risk has decreased in these markets. In terms of sectors, we favour real estate, especially logistics, residential, banks (whose revenues are rising thanks to the rise in interest rates in Europe and the improvement in balance sheets and solvency ratios), and insurance via subordinated debt.
To avoid default risks, the credit quality of the issuers should be the focus of attention. While default rates, which were close to zero, are approaching historical averages, we could be entering a period marked by a greater dispersion of credit ratings between issuers. An active selection approach is therefore required in order to exploit the most interesting opportunities for issuers with robust fundamentals.
In terms of the supply/demand balance, the volume of issuances should be stable in 2023 at around €450 billion on the investment grade market, compared to €475 billion in 2022[2].
As for geographies, we already invest in Euro-denominated debt, as well as US investment grade debt – despite the high costs of hedging currency risk – and we are more and more positive on emerging markets, which should offer interesting entry points next year.
High time for high yield?
While we observe a massive liquidity influx and a low debt cost thanks to the support of central banks, the high yield market shows positive characteristics. Yields are currently around 7% in the Eurozone and 9% in the US[1].
Of course, defaults will rise a bit in 2023 but we have little concern about a large wave of refinancing-related defaults. As for the supply/demand side, we expect issuance volumes to decline in 2023 after last year already being difficult on the primary market, which reinforces our view that refinancing needs are not immediate.
Our biggest concern in this market is the risk of a recession in an environment of limited monetary and fiscal policies, while the risk of inflation remains.
A resilient green bond market
Green bond market resilience has been very important this year, despite the volatile environment. The market remained dynamic and offered interesting investment opportunities. With a bit less than $400 billion issuances this year[2], the volume of issuances has been remarkable compared to other markets. More than 90 new issuers[2] have issued a green bond, from the real estate and automotive sectors, as well as sovereigns such as Canada and Austria, confirming the interest of issuers and investors in this asset class.
Now more than $1 trillion[2] in size, the green bonds market has established its expansion this year, despite a negative performance in line with market fundamentals.
Finally, with the carbon intensity of the projects financed by green bonds representing half that of these issuers[3], green bonds should continue to attract new investors in 2023.
[1] Indices credit ICE BofA, 2022
[2] AXA IM Bloomberg, 2022
[3] S&P Trucost, 2022
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