Navigating Rates

Fixed income outlook: harnessing a higher-for-longer conviction

A shifting outlook for inflation, interest rates and economic growth is creating a complex market environment. But we think investors may now be starting to come around to our belief that interest rates are likely to have to stay higher for longer to tame sticky inflation. With the prospect of further near-term market instability, investors may want to consider remaining flexible and deploying their risk budgets tactically and incrementally.

Key takeaways
  • Investors are facing a complex environment, with uncertainties surrounding inflation, interest rates and economic growth.
  • Strong recent US jobs data and a commitment by the Federal Reserve to taming inflation indicate interest rates may stay higher for longer – and investors may now be starting to believe that outlook.
  • The role of central banks will remain in focus; policymakers will be hard-pressed to shake off the perception of “bond market-makers” or “fiscal-policy underwriters”.
  • Investments geared at minimising volatility may help guard against the risk of fresh market fluctuations caused by changes in inflation and economic growth outlook.

Investors searching for clues about the likely direction of interest rates could be forgiven for scratching their heads. Falling inflation and signs that the economic outlook may not be as bad as feared had fuelled hopes major central banks – foremost the US Federal Reserve (Fed) – may soon begin to pivot away from a path of higher interest rates they have pursued since 2022. In response, markets rallied across the opening weeks of 2023. But the release of the latest US jobs data showed employers hired more workers than expected in January.1 Bonds sold off as investors shifted gears – believing the latest data suggested the US economy may be running too hot and that the Fed would have to stay the course with policy tightening.

In our view, investors may now be coming around to our belief that central banks will likely have to keep interest rates elevated to tackle sticky core inflation. In short, interest rates may have to stay higher for longer. We think this belief is reinforced by the latest messaging from the Fed and the European Central Bank. Fed chair Jay Powell and ECB president Christine Lagarde have both reaffirmed their central bank’s willingness to keep rates high to ensure a sustainable decline in inflation towards its price stability objective.

Going forward, we expect central banks will be hardpressed to shake off any market perception of their role as “bond market-makers” or “fiscal-policy underwriters” of last resort. As expectations around liquidity and fiscal dominance come to an end, expect bouts of market volatility.

Shifting economic growth outlooks may compound uncertainties in a complex market environment. Our proprietary leading indicators forecast that global growth continues to run below its trend rate over the coming months. We expect recessions in the US and Europe, given headwinds from tightening financial conditions and the squeeze in household real incomes, although the slowdowns may be milder than previously anticipated.

Focus on quality and beware of volatility

Measures of implied and realised bond volatility have eased from their recent highs last year. But the shifting macro outlook means there might be further instability. In this environment, it may be wise to avoid taking too much outright, one-directional risk in portfolios in the near term. Ideas to think about in the near future:

  • Considering the inherent macro uncertainty at this point of the rates and credit cycle, it may be the wrong time to aggressively increase outright duration or credit risk.
  • Many government bond yield curves are flattish to inverted, so short-maturity bonds could lock in yield income as high as – or even higher than – that offered by long-maturity debt. But investors should remember: short-maturity bonds may not help much to dampen portfolio volatility as the front-end of yield curves remains vulnerable to further shocks from the repricing of terminal short-term rates.
  • Combining short-maturity cash bonds with derivatives-based overlay strategies that can help minimise rate, spread and currency volatility may help in this environment. It’s important to note that there can be cash outlay and performance costs associated with these hedging strategies.

Fundamentals are a lot better than heading into previous periods of economic slowdown, but there’s still uncertainty over terminal policy rates and the fallout for growth. Our outlook continues to favour defensive positioning in fixed income with plenty of room ahead to add risk gradually through higher-quality debt sold by higher-quality issuers.

1 Source: US Bureau of Labor Statistics: Employment Situation Summary - 2023 M01 Results (bls.gov)

  • Disclaimer
    This is for information purposes only and not to be construed as a solicitation or an invitation to buy or sell securities. There is no guarantee that these investment ideas will be effective under all market conditions and investors should evaluate their ability to invest for the long-term based on their individual risk profile, especially during periods of downturn in the market. Investing in fixed income instruments may expose investors to various risks, including but not limited to creditworthiness, interest rate, liquidity and restricted flexibility risks. Changes to the economic environment and market conditions may affect these risks, resulting in an adverse effect to the value of the investment. During periods of rising nominal interest rates, the values of fixed income instruments (including short positions with respect to fixed income instruments) are generally expected to decline. Conversely, during periods of declining interest rates, the values are generally expected to rise. Liquidity risk may possibly delay or prevent account withdrawals or redemptions.


    Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

    The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

    This material has not been reviewed by any regulatory authorities. In mainland China, it is for Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations and is for information purpose only. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional/professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.

    This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; in HK, by Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; in Singapore, by Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; in Japan, by Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424], Member of Japan Investment Advisers Association, the Investment Trust Association, Japan and Type II Financial Instruments Firms Association; in Taiwan, by Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan; and in Indonesia, by PT. Allianz Global Investors Asset Management Indonesia licensed by Indonesia Financial Services Authority (OJK).

    2738252

Recent insights

Embracing Disruption

Discover how China and its impressive economic growth over recent decades have become an important sales destination for European companies.

Discover more

Achieving Sustainability

China has a distinctive corporate landscape with state-owned enterprises and companies with large single shareholders. Does this mean engaging with Chinese companies requires a customised approach?

Discover more

Embracing Disruption

Pet humanisation is fueling the demand for premiumisation of food, healthcare and services with especially the Asian pet market showing staggering growth.

Discover more

Allianz Global Investors

You are leaving this website and being re-directed to the below website. This does not imply any approval or endorsement of the information by Allianz Global Investors Asia Pacific Limited contained in the redirected website nor does Allianz Global Investors Asia Pacific Limited accept any responsibility or liability in connection with this hyperlink and the information contained herein. Please keep in mind that the redirected website may contain funds and strategies not authorized for offering to the public in your jurisdiction. Besides, please also take note on the redirected website’s terms and conditions, privacy and security policies, or other legal information. By clicking “Continue”, you confirm you acknowledge the details mentioned above and would like to continue accessing the redirected website. Please click “Stay here” if you have any concerns.