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Thought of the day

US Treasury yields fell on Wednesday after fresh US jobs data continued to show a gradual easing in labor market conditions. Job openings in November dropped to the lowest level in 14 months, while the increase in private payrolls in December came in below consensus estimates. The 10-year yield fell 4 basis points to 4.13%.

While markets remain focused on the official employment report due Friday, the latest set of jobs data should pave the way for another interest rate cut by the Federal Reserve this quarter, in our view. This would provide a tailwind for quality bonds, which we believe continue to play a key role in generating portfolio income for investors.

We expect medium-duration quality bonds to deliver mid-single-digit returns this year. High-quality, medium-duration government bond indices have delivered mixed results in recent weeks as investors balance central bank decisions with lingering concerns about inflation and government debt sustainability. But with a combination of attractive starting yields and the potential for them to move lower amid Federal Reserve easing, we expect respectable returns from a mix of yield and capital appreciation. Investors should also remember the diversification benefits quality bonds offer.

Technicals remain healthy despite record bond issuance. Bloomberg data showed that global bond sales had their busiest start to a year so far, with corporations and governments in the US, Europe, and Asia having borrowed some USD 245bn across currencies through 7 January. In the US, investment grade firms have raised nearly USD 90bn so far this week, the most for any week since May 2020. But while more bond issuance is in the pipeline, tight corporate bond spreads suggest that investor appetite for credit remains strong, reflecting the appeal of outright yields and prospective returns. Some firms were even able to attract orders several times the size of their offerings. We view this as a sign of healthy technicals in the market, with robust interest and ability to absorb additional supply.

We see value in a diversified approach to income generation. Given tight credit spreads and uncertainty around government debt, we think a diversified approach to yield generation is essential. In addition to high grade government and investment grade corporate bonds, income-seeking investors can consider select high yield and emerging market debt to help enhance yield. Additionally, we see value in equity income strategies, yield-generating structured investments, and select private credit exposure.

So, while lower rates may mean income opportunities are becoming scarce, quality bonds should continue to play an important role as a source of yield and diversification, among other strategies to boost income.