Time to switch to US bonds?

High-grade US bonds are performing better than equities in the face of the US Federal Reserve hiking interest rates to contain inflation, Goldman Sachs said in its 2023 Outlook for Asset Allocation. 

Since the 2008 global financial crisis in the US and post the Covid-19 pandemic, US equities have performed historically well compared to bonds. Bond yields plummeted after both events and investing in equities, in trying times, was a far better deal than investing in fixed income. But the economic downturn in 2022 has pushed up bond yields and consequently potentially less risky alternatives have emerged in fixed income.

As the risk premium for equities is low compared to bond yields, low-risk bonds are increasingly becoming an alternative. In comparison to lower-risk credit, investors aren’t getting much compensation for the risk of owning equities or high-yield credit. As a result, equities and high-yield debt are particularly vulnerable to a slowing or recessionary economy according to Goldman Sachs. The risks for the US equity market are increasing going into 2023, while bonds may become further tempting.

“That just makes equities and riskier debt very vulnerable for disappointments on growth next year. There is less incentive to go up the risk curve because there’s not much risk premium,” writes Christian Mueller-Glissmann from Goldman Sachs.

Even though yields have been volatile as of late, Goldman Sachs predicts inflation to subside in 2023 as economic growth takes the centre stage. The assumption is that the yield volatility in bonds has peaked.

Historically, bonds have offered protection to investor portfolios. If the stock market and Treasuries fall in price owing to stickier inflation in 2023, US bonds could go on to offer a more diversified benefit to investors, says Goldman Sachs

However, “until central banks stop hiking and inflation normalises further, they are unlikely to be a reliable buffer for risky assets,” adds Mueller-Glissmann.

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