Lord Abbett: 2024 Bond Market Outlook Midyear Update

In Brief

As we navigate to the back half of 2024, we remain constructive on fixed income as an area to generate attractive risk-adjusted total returns in investors’ portfolios. Our base case for optimism rests on both macro and fundamental factors, but live debates remain across the investing landscape requiring both a healthy dose of skepticism as well as humility. The most obvious tensions fixed-income investors need to contend with remain 1) probability weighting the various potential paths of monetary policy, 2) reconciling reasonably tight credit spreads in many sectors against historically attractive all-in-yields and 3) ensuring portfolio resiliency against a range of possible outcomes that could surface in the second half.

Focus Less on Cuts and More on Conditions

We can all recall that as recently as the start of 2024, consensus expectations were for the Fed to ease by almost 175 basis points (bps) this year. Today, that expectation has moderated significantly, down to just one or two eases of 25 bps given continued, but uneven progress towards the Fed’s inflation goal. Economic resiliency reigns despite monetary policy that would normally be considered reasonably restrictive. But we are seeing some evidence of both normalization from elevated levels in pockets of consumer spending and some softness in consumer segments particularly impacted by sticky inflation.  Both realities are leaving benchmark rates moderately lower from their recent peaks. While data-dependency rings true with our investing teams, we consider a resumption of policy hikes a low probability event, but a key vulnerability to risk asset performance. The most definitive observation we can make is that inflation expectations remain generally well anchored, suggesting markets and consumers retain confidence in the Fed.

Carry Continues to Win with a Focus on Lower-Rated, Short-Term Maturities

Across strategies, we continue to lean into areas of credit—both securitized and corporate— where attractive yields potentially offer some measure of forward return predictability, even if we do not see meaningful spread tightening from here. And of course, we must always consider “what’s in the price?”  For example, one of the leading areas of fixed income returns this year has been commercial mortgage-backed securities (CMBS). Many fundamental concerns remain, particularly in the office sub-sector, the overriding negativity in this space to start 2024 created viable opportunities now being captured. We believe many idiosyncratic opportunities to both gain and shed exposure remain across securitized products.

In the corporate space, the higher-for-longer environment has kept our start-of-year preference for short-dated and floating-rate exposure largely in place. Longer-dated, core bond exposures have a portfolio role. They include hedging against tail outcomes—a recessionary narrative as well as a quicker fall in inflation than we currently see. But a preferred approach includes bundling this exposure with front-end credit including short-duration high yield and bank loans that both take advantage of a still moderately inverted yield curve, manageable default expectations, all while potentially paying investors handsomely as we await further detail on the Fed’s direction (see Figure 1).