Assessing the outlook for bond markets in 2024
Hilary Blandy looks ahead to 2024, asking what makes the UK different on inflation and whether parts of the bond market might crash into a ‘maturity wall’.
![Hilary Blandy Jupiter Fund Manager, Fixed Income](https://www.jupiteram.com/uploads/2020/11/105708c0d7951e04b6f015d2f5aa4b18/hilary_blandy_350x350.jpg?r=bf4366cf820771fa0196f1cfc9fb4b99&v=1677850651)
So, is the UK out of the woods when it comes to inflationary worries? I would argue not. Annual growth in regular pay (excluding bonuses) for UK workers is currently at one of the highest levels since comparable records began in 2001, according to the ONS. What is more, at 7.3%, pay growth is exerting upward pressure on the headline level of CPI. 2 Whilst the near-term outlook looks promising for the path of inflation, I believe that inflation may start to tick up again unless there is a material change in the jobs market
There are other factors, specific to the UK and not present for its developed market peers, that in my view will also conspire to slow at which inflation falls. The way the UK’s energy market is regulated means that energy costs remained higher for longer than in many other markets resulting in a longer period of sustained upward pressure on inflation. At the same time, the size of the UK’s workforce has been slower to recover from the dip seen during the pandemic. The corresponding lack of workers in the UK is helping to drive pay growth.
Furthermore, the UK had more strikes in 2023 than any other year since the 1980s. Despite some deals being struck, many workers have still seen their pay fall in real terms compared to before the pandemic. Unions may therefore be encouraged by success achieved so far and continue to ask for more pay, even with inflation dropping. There’s also the election factor. With a general election widely expected to take place sometime in 2024, there will be an incentive for the government to increase spending which may ultimately result in further upward pressure on inflation. This may lead to elevated risk of another interest rate rise or at least require the Bank of England to maintain rates at high levels for longer.
The interest rate question is a critical one for bond investors. Views across the market clearly will differ, but my own take is that the Bank of England may fail to deliver the level of interest rate cuts that bond markets seem to expect in 2024 without a very big rise in the unemployment rate and at the same time a slowdown of pay growth. While those outcomes are possible in theory, they are not what I would most expect to transpire in 2024.
Bonds issued by companies with relatively high credit ratings (‘investment grade bonds’) have been slow to feel the impact of interest rate changes so far and I would expect these companies should be able to handle the higher cost of debt quite easily. However, higher debt costs will still need to be accounted for elsewhere, for example by raising prices or cutting costs.
In the ‘high yield’ part of the bond market (where companies have lower credit ratings than ‘investment grade’ bonds) the rising cost of debt is potentially more problematic as companies issuing these bonds sometimes won’t have robust enough financial health to absorb these higher costs.
As usual, the key is in the detail. Companies do have other levers they can pull to manage their debt; for example, stopping returns of capital to shareholders or slashing their own capital expenditure, although this may leave little wiggle room in an environment of slower economic growth. Another strategy that has become popular in the current high interest rate environment is the use of “Amend and Extend”. This tactic is usually used when companies think that investor demand would be insufficient to achieve a normal bond refinancing, but when the situation is not seen to be bad enough to require a full restructuring. These solutions are usually based on the implicit assumption on both sides that the interest rate environment will improve and that a full refinancing will be done at market terms and at lower rates. Pushing the problem further into the future in this way is risky, in my view.
My expectation for 2024 is that it will offer a great chance for bond investors to potentially benefit from the high yields that the asset class currently offers, providing that credit research teams can be successful in telling the difference between companies that can refinance their bonds easily and those that might have difficulties.
For investors like us that are able to balance the two, a mix of investment grade and high yield bonds – backed up by smart credit research – I expect there will be some enticing opportunities available in 2024.
- Currency (FX) Risk – Bonds can be exposed to different currencies and movements in foreign exchange rates can cause the value of investments to fall as well as rise.
- Interest Rate Risk – Bonds are assets whose value is sensitive to changes in interest rates meaning that the value of these investments may fluctuate significantly with movement in interest rates.e.g. the value of a bond tends to decrease when interest rates rise
- Pricing Risk – Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
- Credit Risk – The issuer of a bond or a similar investment may not pay income or repay capital when it is due.
Outlook 2024: A pivotal year?
Periods of transition often raise interesting questions, and this year investors are faced with plenty as they look ahead to what 2024 may bring. Will Western central banks finally start cutting interest rates? Will geopolitical tensions calm or further escalate? And what might a fraught US Presidential election mean for the world?
Outlook 2024 Articles
Outlook 2024: Why quality matters in European equities
Outlook 2024: India’s booming as voters back pro-growth Modi
Outlook 2024: Rampant debt and a rancorous election
The value of active minds: independent thinking
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