Fixed income Fixed income Investors no longer need to reach for yield by Higher break-even rates (from higher yields) taking unnecessary credit risk act as ‘shock absorbers’ In a regime of ultra-low government bond yields Break-evens in this context simply refer to the and steep yield curves, investors in developed magnitude of rate increases needed to wipe out 3 3 markets bonds were faced with a rather difficult 22 the head-start provided by yield income from a trade-off: generate higher yields by going out further on total return perspective. In general, the higher the level of the maturity curve and taking on more interest rate risk, yield, the larger the magnitude of rate increases required or take on more credit risk by moving down the credit to generate a negative total return (i.e., wipe out positive quality spectrum. contribution from income). In Table 1, we show break-evens for major fixed income asset classes and how much they have As Chart 4 shows, at the end of last year, only a quarter of changed since the beginning of the year. the market offered yields of more than 2% (in USD). Today, this universe has more than tripled to 83%. We would argue Looking at the Bloomberg Global Aggregate Index, break- that this development allows for a much better starting point evens were at 17 bps at the beginning of the year; they are for investors to achieve their investment goals, with an ability now at 57 bps. The Global Aggregate Corporates Index has to build a much more diversified portfolio in terms of both risen from needing 25 bps of yields rising to 92 bps before issuers and sectors. negative total returns set in. The short duration sectors are really shining: this is because curves have flattened, and short Risks in a world of rising yields duration assets have much less interest rate sensitivity. At the Investors now have much greater flexibility to achieve their end of 2021 the Global Aggregate 1–3 Year Index required yield targets, but clearly, while there are benefits to having just a 38 bps rise in bond yields to generate a negative return. higher yields today, we should keep in mind that, with the More recently, this same benchmark now requires nearly 190 Federal Reserve and other central banks focused on stamping bps of yield increases to erase its higher yield advantage. out persistently high inflation, markets are likely to remain volatile over the short-to-medium term. However, for long- term investors, bonds are arguably better placed today to handle any further price declines than in the past. Table 1:Change in break-evens for major fixed income asset classes in 2022 YTD Chart 4: The growth in the proportion of the fixed income market yielding 2% or more Index Break-even at end Dec 2021 Break-even at end Oct 2022 Extra cushion to absorb 30 (bps) (bps) rising yields (bps) 83% Bloomberg Global Aggregate Index 17 57 40 25 3x 20 Bloomberg Global Aggregate 1-3 Year Index 38 189 152 15 25% Bloomberg Global High Yield Index 114 242 128 10 Bloomberg Global Aggregate Corporates Index 25 92 66 5 ICE BofA 1-3 Year Eurodollar Index 63 283 220 0 Dec-21 Oct-22 JPM EMBI Global Diversified Index 66 148 82 Global Treasuries Global Gov Related Global Corporate Global Securitized Global High Yield Source: Bloomberg, JP Morgan, ICE BofA, as of end October 2022 Source: Bloomberg, as of end October 2022 The Global fixed income universe is proxied by the Bloomberg Multiverse Index. The Bloomberg Multiverse index provides a broad-based measure of the global fixed income bond market: The index is the union of the Global Aggregate Index and the Global High Yield Index as it represents investment grade and high yield bonds in local currency terms 12 13