Main asset classes Fixed income 28 | 29 Watch the curves For 2023, we expect the yield curve to steepen, i.e., As the Fed hiked interest rates aggressively, bond the spread between 10-year and 2-year yields to Worst may be over for yields rose more for short maturities than for longer increase. The extent of this steepening will depend maturities. For example, the spread between the on the macro circumstances. A scenario in which 10-year and 2-year US Treasury yields declined from the Fed reacts to rising recession risks by cutting +80 basis points at the start of 2022 to –50 basis interest rates would most likely lead to a significant fixed income points at the end of Q3 2022. Long-term yields are yield curve steepening, as short-term yields would currently lower than short-term yields because the fall more than long-term yields. But even in our base market expects economic growth to slow and case of a normalizing economic outlook (i.e., growth monetary policy rates to fall again over time. remains below trend), some gradual steepening of the US yield curve can be expected. With monetary policy tightening likely to slow or end in 2023, we believe fixed income assets will become more attractive to hold. Particularly, emerging market hard currency bonds are likely to deliver high returns. Moreover, if inflation declines as we expect, we think that fixed income, especially government bonds of countries with fiscal policies that can be sustained, should offer valuable diversification benefits in portfolios. Risks to the asset class include a renewed phase of volatility in rates, for example due to higher-than-e xpected inflation. Elevated inflation has prompted central banks higher, weighing on the asset class from a total around the globe to hike interest rates meaningfully, return perspective. If inflation indeed cools, as we leading to a sharp tightening of global monetary expect, we believe that government bonds will offer US rates should peak with activity slowing conditions. Given the shock of high energy prices valuable diversification benefits for multi-asset 10-year US Treasury yields vs. US ISM index and rapidly rising inflation expectations, central portfolios. banks were forced to hike interest rates faster and 3.0 more forcefully than in previous tightening cycles. Higher return potential in US Treasuries 25 Bond yields rose significantly in both nominal and Across the major markets, we see the most duration 2.5 real terms, including sovereign bonds in developed potential in USD, and less in EUR. The US Federal 20 2.0 markets. Both US and Bund 10-year yields are up Reserve (Fed) started to hike rates earlier and more more than 200 bp in the year to date, currently at meaningfully than the European Central Bank (ECB), 15 1.5 3.81% and 2.01%, respectively, as of 10 November. which maintained negative interest rates until July 2022. Not only does the ECB have to catch up now, 10 1.0 Our expectation is that central banks will slow the but the Eurozone is also facing higher inflation and 0.5 pace of rate hikes or end hikes altogether as greater uncertainty regarding energy prices this 5 economic growth deteriorates and inflation cools. As winter. High inflation together with currency weak- 0.0 central bank expectations stop driving yields higher, ness will likely force the ECB to raise rates aggres- 0 the return outlook for sovereign bonds should sively even in a recession. Given the current rate – 0.5 improve significantly. In contrast to 2022, we differentials and the different outlook in terms of – 5 –1.0 anticipate that the return outlook for global treasury further rate hikes, we see greater return potential in indices will be positive in 2023. Opportunities to US Treasuries than in Eurozone government bonds. –10 –1.5 increase duration in bond portfolios are also likely to Heightened concerns about European sovereign – 2.0 arise once bond yields approach their cycle peaks. debt could make this relative move even more –15 Government bonds have seen their performance pronounced. – 2.5 weaken alongside risk assets, as rising inflation 2008 2010 2012 2014 2016 2018 2020 2022 drove policy rates and the whole yield structure US Treasuries 10y yield (12-month changes, rhs, %) US ISM (12-month changes, index) Last data point 31/10/2022 Source Bloomberg, Credit Suisse