Navigating key questions in fixed income investments

CONTRIBUTORS

Christy Tan

Investment Strategist
Franklin Templeton Institute

Lukasz Labedzki, CFA

Senior Analyst
Franklin Templeton Institute

Key takeaways:

Resilience in yields: Despite recent market shifts, yields remain attractive to fixed income investors. This paper delves into key and thematic questions, concluding that many risks are already factored into market prices, providing a solid buffer for those investing with a long-term perspective.
Geopolitical risks and rate cuts: Rising geopolitical tensions could delay the anticipated rate cuts. However, these same risks underscore the vital role of fixed income investments as stabilizers within investment portfolios, enhancing their value during volatile times.
European rate outlook and challenges: While the pathway to rate cuts appears more straightforward in Europe, the high hedging costs could dampen investors’ enthusiasm for EUR-denominated bonds.

Second quarter (Q2) 2024 highlights

In Q2 2024, the conviction-based Franklin Templeton Institute’s US Fixed Income Navigator (FIN) moderated, bringing us back into upper bound of neutral territory. We assess the balance of risks and opportunities that underpins the current reading.

Exhibit 1: Fixed Income Navigator Dashboard

March 2024 Update

Source: Franklin Templeton Institute.

Undeniably, yields are still attractive in the fixed income space, nearing the highest levels in more than a decade. Market pricing is now more conservative, and that effectively reduces the risk of abrupt repricing. Risk-reward profiles for high-quality intermediate bonds are in favor of taking some interest-rate risk, especially for buy and hold investors. Increasing geopolitical instability can trigger some “flight to safety,” resulting in a greater appetite for Treasuries.

From the risks perspective, the Federal Reserve (Fed) might keep rates higher for longer amid the relative strength of the US economy and growing concerns about inflation. As a result, the market may be pricing in higher terminal rates. Another risk is the increased supply of coupon bonds with less demand at current prices. More importantly, an escalation of geopolitical risks (especially in the Middle East) can lead to another inflationary impulse.

In this paper, we explore some key and thematic questions that are relevant to fixed income investors.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility.

Important Legal Information

This document is for information only and does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

Any research and analysis contained in this document has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. Any views expressed are the views of the fund manager as of the date of this document and do not constitute investment advice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole.

There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from the use of any information, opinion or estimate herein.

The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.