INVESINVESTMENT OUTLTMENT OUTLOOK FOR 2023OOK FOR 2023 -- 15 -15 - Focus on fixed income - A new bond world Fixed income bonds saw unprecedentedly poor returns in 2022, with all key sectors posting a negative performance (as at 10 November 2022) due to a normalisation of policy rates, recession hurting credit spreads, and liquidity shocks driving up volatility. After a more than 50-year bull market, a new bond world has emerged in which it is now possible to earn a positive absolute performance. Central banks have managed to drive interest rates to normalised levels, meaning rates should not need to rise meaningfully from here. Five year-five year real yields in the US and the eurozone have returned to their post-Global Financial Crisis highs. Consequently, carry will be essential in generating returns in the future. Investors should recall that historically, carry accounts for the bulk of fixed income total returns. The transition to the new world is not complete, however, meaning volatility will likely remain high and asset allocation is crucial. 2023 will see both growth and inflation decelerate and accelerate, calling for different allocations depending on the macroeconomic regime. Any return to fixed income should focus on core assets such as money market instruments, government bonds and investment-grade credit, alongside diversifying satellite investments in flexible bonds, green bonds and emerging market debt. Investing back in money markets is attractive as they offer visibility thanks to short duration, and now attractive yields given the substantial rise in short-term rates. We could see declines in US policy rates by the end of 2023, though this is less likely in the eurozone. We believe eurozone investment-grade credit is attractive as spreads at the time of writing are commensurate with much higher default rates than we think will actually materialise. Exhibit 1: Bond market themes for 2023 Normalisation is done Central banks have normalised rates (NEW WORLD) 1 Volatility is possible Allocation is crucial (PERFORMANCE) Carry is essential Investors must capture yields (RETURN) Source: BNP Paribas Asset Management as of November 2022