Jack McIntyre, portfolio manager at Brandywine Global, a specialist investment manager of Franklin Templeton, on the year of the 'coupon+' and lower inflation
This article was produced in partnership with Franklin Templeton
Last year saw the Achilles heel of bonds revealed through swiftly escalating rates, which in many instances slashed their value by double-digit percentages. In the past two years, surging inflation compelled the U.S. Federal Reserve, the Bank of Canada, and other global central banks to raise interest rates rapidly and to an extraordinary extent, impacting more than just the fixed income segment of portfolios.
Jack McIntyre, portfolio manager at Brandywine Global, presents a nuanced outlook for 2024, describing it as the year of the “coupon+.” As global economies navigate shifting financial conditions, McIntyre's analysis offers a deep dive into the factors shaping bond markets in developed economies. With inflation falling sharply and major developed market central banks about to embark on rate-cutting cycles, the macroeconomic environment is generally favorable for bonds. Unlocking the “coupon+” will not be a passive ride: it will require actively identifying the most attractive credit, country, and currency opportunities.
A pivotal year ahead
The portfolio manager references the historical performance of the 10-year US Treasury note. “We are anxiously waiting to see if, for the first time in history, the 10-year US Treasury note records three consecutive years of negative returns,” he states, setting the stage for a year that promises to deviate from the trends of 2023.
The focus for 2024, as McIntyre explains, is influenced by the rippling effects of tightened financial conditions and diminishing fiscal support. These elements are expected to cool the economy, marking a distinct shift from the previous year.
The concept of “coupon+”
Central to McIntyre's thesis is the idea of the “coupon+.” This concept encapsulates not just the traditional bond coupon returns but also the potential for price and currency appreciation. “We expect 2024 to be the year of the ‘coupon+,’ with the ‘+’ representing potential boosts of price appreciation and currency appreciation from a weaker U.S. dollar,” McIntyre notes.
Shifting dynamics in inflation and labor markets
In an interesting deviation from historical trends, McIntyre points out that inflation, long the critical variable for bond markets, is being overshadowed by labor market dynamics. “For the first time in decades, inflation is not the critical variable for bond markets. It will be potential weakness in the labor markets because of the concept of term premium embedded in real yields,” he asserts, “It is signaling that bond investors do not believe inflation will settle near the Federal Reserve’s target.”
McIntyre discusses both outright valuations against inflation expectations and relative valuations compared to equities and credit-oriented fixed income markets. “For the first time in a long time, bond yields are above earnings yields,” he notes, suggesting an environment where bonds are relatively inexpensive compared to equities.
Geographic divergence and investment implications
McIntyre anticipates that U.S. Treasuries will set the tone for broader developed markets (DMs) and likely outperform due to significant domestic economic slowdowns. Conversely, China is expected to provide economic stability, positively impacting Asia and Europe.
“Investment implications are that overall, we are constructive on DM bonds,” McIntyre concludes, albeit acknowledging the uncertainty in the path and timing of these developments. He anticipates changes in Federal Reserve rhetoric and economic pressures in the U.S., contrasting with economic stabilization in China.
“Lagged tightening of financial conditions should fully hit during 2024. We expect Fed rhetoric will change in early 2024, followed by weak labor data. Rates will stay high until something breaks, that something being inflation, financial markets, or the economy.”
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