Most clients own a combination of equity and fixed income assets within their portfolio. A least preferred view of equity and most preferred of fixed income does not mean all-or-none, but it is guidance for how risk dollars should be allocated. Currently, we prefer fixed income over equity. We recently moved our high yield allocation from least preferred to neutral.
However, a neutral stance is not an indication that investors should go long high yield (HY) beyond what their own portfolio benchmark deems appropriate. With current HY spreads at 450bps, the sector is in the 41st percentile over the past 25 years. That is, since 1998, HY spreads have been wider than today 59% of the time. The move to neutral is due to the 8.5% yield the sector is generating alongside its higher correlation to equity.
Post-Fed pause, we look for volatility to subside and those sectors with higher embedded credit risk can offer generous yields. We expect a continued slowdown into 2H23 but are not projecting a hard landing. We are neutral on those sectors whose total return will be enhanced by greater carry but will face headwinds of tighter lending standards, and most preferred on those sectors that exhibit well above average yields but exhibit a negative correlation to the equity market. As the equity market underperforms in the second half of 2023, these sectors should outperform.
We set the current range of 10-year yields at 3.25–3.7%. We entered the year long incremental interest rate exposure and added at 3.97%. It’s not necessary to chase the market as the Fed may move again in June. Investors should begin to lock in rates incrementally for the longer-term in anticipation of a Fed easing and even lower 10-year yields.
Read the full report Fixed Income Strategist: Preparing for a pause 2 May 2023.
Main contributor: Leslie Falconio
This content is a product of the UBS Chief Investment Office.
Watch the video for more on CIO's latest views on the Fed, inflation, and fixed income positioning.
Listen to the podcast for more on the current landscape for fixed income investors and where to locate opportunity within the asset class.
