Dan Ivascyn, chief investment officer at PIMCO, noted a resurgence in bond performance after a challenging period.
Speaking at the Morningstar Investment Conference, Ivascyn highlighted the growing appeal of certain segments within the bond market, citing promising valuations.
“It’s been rough to be in fixed income versus cash,” Ivascyn said.
“2024 was really rough when nearly everything was going down. Equities were going down and normally fixed income helps temper the volatility of a negative equity environment and it didn’t. It went down as quickly as stocks.”
This scenario sparked significant concern regarding extending into longer maturities, which persists to this day, the CIO explained.
“When you look at where we are now in this tightening cycle, where the Fed has likely hit the peak in terms of policy and you look at lags from a monetary transmission perspective, this is a time where the historical data would suggest it makes a lot of sense to extend from cash into fixed income,” Ivascyn said.
His observation, he said, stems from the usual trend during this phase of the cycle, which often sees a shift towards rate cuts.
“Given that the forward curve has only priced in a couple of cuts, we do think this is a very, very attractive time to shift from cash into locking in some of those returns,” he expounded.
From a global perspective, Ivascyn recommended that Australian investors currently holding cash consider exploring domestic bonds, while also advising US investors with cash to consider opportunities in Australia.
“They could either do it on an unhedged basis, that looks reasonable to us, but when you hedge back into the US dollar, you have a situation where you pick up very, very attractive yields. You have a country with a very, very strong fiscal position, an economy that has a bit more rate sensitivity than the US,” he said.
Touching on ongoing geopolitical tensions and still sticky inflation as reasons to steer clear of bonds for a little while longer, Ivascyn admitted that uncertainty does remain. However, he reiterated that current valuations support reallocating some funds from cash to fixed income, as well as transitioning from equities to fixed income as a de-risking strategy.
“It’s always hard to time market turning points, but when you have a valuation advantage, start allocating back into that sector,” he advised.
“We’re not through this period of uncertainty, so just head in that direction and maybe leave a little bit of flexibility to add on further weakness.”
Adding to this, Ivascyn stated the obvious – “higher rates are not going to be great for bonds”. However, he said higher rates at this stage may be worse for equity markets and more credit sensitive areas of the economy.
“Cash may prove to be king, but we are at the point in the cycle, we’re at valuation where the risk reward proposition for global fixed income is looking better and better.”
‘Putting our money where our mouth is’
On Australia, Ivascyn said PIMCO expects the Reserve Bank to cut rates later this year.
“Similar to the US, there’s a lot of uncertainty,” he explained.
“But when we look at Australia, we do think you have an economy where the rate transmission mechanism is more efficient than what we see in the US, and we do think you’ll make continued progress on the inflation front, and in this cycle, you will potentially see some decoupling in policy and you may see the RBA able to cut ahead of the Fed, and in some degree, more than the Fed.”
Value, he noted, is looking “pretty darn good in Australia”, both absolute and relative.
“We’re adding Australian interest rate exposure across our broad diversified strategies … Putting our money where our mouth is,” he said.
Earlier this month, State Street research revealed a shift in investor sentiment towards fixed income during April. However, the firm emphasised that this trend was predominantly focused on Treasuries, indicating a minimal appetite for riskier assets such as emerging market debt or high-yield corporate credit.
Notably, cash holdings returned to their long-run average over the month, leaving fixed income holdings as the “prime beneficiary”. Namely, allocations rose 0.4 percentage points to 27.9 per cent, the biggest monthly rise in fixed income allocations since March 2023.
“April was a frightful month for bond and equity market returns, but the reaction of institutional investors was telling,” said Michael Metcalfe, head of macro strategy at State Street Global Markets.
“Rather than hide out in cash, they increased their allocation to fixed income by the most in more than a year. A prescient move given the high, not higher, for longer message on rates from the Fed at the beginning of May and perhaps the beginning of investors reassessing their still significant underweight in bonds.”
