The Federal Reserve left interest rates unchanged at its June policy meeting, after 10 consecutive rate hikes since March 2022. The Fed has expressed that they are on a data-dependent mode, and the dot plot suggests two more 25 basis points hikes for the rest of 2023. We are of the view that we are close to the end of the tightening cycle, even though interest rates may stay higher for longer as inflation is not coming down as fast as the Fed had expected.
The current high interest rate environment provides a good opportunity to lock in decent bond yields at elevated rates. Bond yields now are indeed attractive relative to equity markets. Bonds also offer the potential for capital appreciation should we enter a recession.
Markets are predicting the US economy to enter a recession in 2H 2023. We are also seeing growth headwinds from Europe and China – the Eurozone economy is losing momentum after a strong 1Q 2023 due to the tailwinds from declining energy prices, while China’s weak April activity data suggests that its post COVID recovery could have stalled amid worsening geopolitical tensions.
With a heightened level of uncertainty, we stay defensive and prefer short duration, high quality fixed income to lower our interest rate and credit quality risk. We maintain a highly diversified portfolio, and exercise prudence in our bond selection.
Spreads in certain segments of the credit market remain wide as investors may not have fully returned to the bond markets on concerns over yield volatility. The banking failures earlier this year had also shaken the market. Furthermore, there are lingering concerns over the state of the Chinese economy.
We are of the view that there will be no hard landing for the US economy, and the banking crisis has been contained without huge systematic risk. In that regard, we do not see major credit risk for corporate bonds headed into 2H 2023. We are also of the view that the Chinese government will step in with further stimulus as growth starts to slow down.
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