32 | 2023 Investment Outlook | December 12, 2022 ƒ We expect credit spreads to remain range-bound in 2023 and are positioning accordingly. We see macro uncertainty limiting the upside of credit ranges beyond their long-run averages. Moreover, we think the lack of economic destruction in a different recession effectively restricts credit spreads in making new wides. We look to carry1 as a driver of returns, with yields at attractive levels. ƒ We are positioned to favor U.S. revenue streams from issuers with bonds denominated in euros. Growth looks more robust in the U.S. than in Europe, but wide swap spreads and attractive cross-currency hedging favor euros. ƒ We expect the financials sector to outperform in 2023, as the weakness in 2022 created by heavy supply and recession concerns continues to abate. What We Are Watching ƒ Supply-side disruption. We expect economies to adapt to the “new order” with new energy supply sources, labor markets addressing shortages and technology advances limiting cost increases. These trends should result in lower inflation in 2023. ƒ Central bank pivots and monetary policy. In an environment of lowering inflation, central banks are likely to pause their tightening cycles, while maintaining optionality for future moves. If this occurs, it should reduce the tail risk for markets—a positive for credit spreads. ƒ China growth. Recent headlines announcing policy developments related to a 20-point plan to address the COVID reopening and a 16-point plan to support the housing sector signal the marginal news may be positive in 2023. ƒ Corporate defaults. Markets are ending the year wondering whether expectations of a spike in default rates is too pessimistic. Looking forward, for credit to perform well, we don’t need good news, just better-than-expected news. ƒ Sustainability. Focusing on ESG could bifurcate between those measuring impact and those centered on financial returns, while still considering sustainability factors. ƒ Technical. The market is sensitive to supply and demand expectations, which reportedly are conservative. ƒ Valuation. European spread underperformance in 2022 reflects the widening of swap spreads and weaker credit markets. Outperformance in 2023 should come from swap spread tightening as German government supply increases. “Many recent trends look positive for credit, including signs of moderating U.S. inflation, supply-side relief in Europe and a potential reopening in China, with lower energy prices.” 1 Carry refers to a strategy that involves two different positions, where the inputs end up being greater than the outputs. Risk Considerations: Fixed income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. ESG - There is no assurance strategies that incorporate ESG factors will result in more favorable investment performance.