Bond Managers Warn of Recession Risk Despite Bull Market in US Stocks
As the US economy has consistently outperformed expectations, some investors may assume that the threat of recession has passed. However, some of the world’s leading bond managers from Fidelity International and Allianz Global Investors recommend hedging risk assets, as they remain convinced of an upcoming downturn and warn against a potentially grave error.
Risk from Central Bank Tightening
According to these managers, central banks are “fighting last year’s battle,” and their hawkishness risks causing something akin to a credit crunch. They predict a bigger crisis than that caused by March’s collapse of three US lenders, with only a pause in rate rise or looser policies causing improvement.
Global fixed-income-focused firms like Fidelity International recommend building up duration risk by investing in interest-rate-sensitive assets such as government bonds, as they are likely to outperform when central banks switch to looser policy. Fidelity International’s CIO, Steve Ellis, predicts Treasury yield falling by year-end as markets realise a recession may be deeper than anticipated.
Allianz Global Investors’ portfolio manager, Mike Riddell, recommends a bullish position in rates and bearish positions in credit. He sees stocks, bonds and corporate debt as mispriced due to their underestimation of risks, with only inflation-rate swaps having the correct outlook. He expects either a moderate-to-deep recession or potentially crises as the unprecedented pace of global policy tightening since in 2022 takes effect.
Investors are confident of at least another 50 basis points of hikes from the European Central Bank during their next meeting, despite the region already brushing with recession in Q1 and Germany, the region’s economic powerhouse, experiencing issues. Additionally, 90% of money market traders are betting on at least another quarter-point hike from the US Federal Reserve in July.
Warnings Against Risky Market Bets
Consumers are increasingly stretched, and portfolios should avoid risky asset bets. Fidelity International’s Ellis notes that even junk-rated corporate bonds look vulnerable to correction. He suggests that the sector is pricing in a corporate default rate of about 4.6%, while it is more likely to rise to almost 8%.
Consumer Pain and the Future
Consumer card balances, an indicator of consumer pain, did not decrease in Q1 this year for the first time in 20 years. Financial professionals like PGIM’s Patrick McDonough warn that consumers being propped up for so long means that a soft landing may not be a realistic option, with the downside becoming increasingly likely.
Despite the US economy’s consistent outperformance, bond managers remain concerned about an upcoming recession. Central bank tightening and the potential for credit crunch have them avoiding risky asset bets like junk-rated corporate bonds and hedging risk assets. Duration risk appears to be the preferred method of hedging in the current bullish stock market.