Bond renaissance 2024—Keeping an eye on the “price”

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Introduction

The Franklin Templeton Institute’s US Fixed Income Navigator (FIN) model has shown significant improvement in Q1 2024, marking a shift to a brighter bond market environment. The primary driver of this shift in perspective is the attractive level of yields across fixed income sectors, a supportive liquidity landscape and, notably, the decrease in inflation and inflation expectations. This decline in inflation is a key factor that increases the likelihood of interest rate cuts and reinstates diversification benefits from bonds.

Despite these positive developments, it is crucial to remain mindful of looming risks. Elevated volatility persists, and the current aggressive market pricing for rate cuts may add fuel to the fire. Additionally, the heightened supply of coupon bonds resulting from substantial US budget deficits poses a risk that is expected to persist for some time. Let’s dig deeper.
 

Q1 2024 Highlights

• In Q1 2024, the model-based conviction has improved, bringing us into positive territory, signaling a more optimistic outlook for bonds.
• Opportunities—Yields in fixed income sectors are in a favorable zone. The increased likelihood of interest rate cuts should support high-quality bond returns, especially if accompanied by a bull-steepening trend. Falling inflation may restore diversification benefits from bonds.
• Risks—Volatility may arise from aggressive and premature market pricing for rate cuts. Higher supply of coupon bonds is another risk, but this can be mitigated by a tapering and eventual ending of quantitative tightening.