Janus Henderson Investors has reduced its underweight position in bond duration within its multi asset portfolios as it believes the upside to interest rate expectations has become more limited.
While central banks in the eurozone, UK and US look to push through some sizeable interest rate hikes before the end of the year, Paul O’Connor, head of multi asset at Janus, said the group’s central case scenario for these economies is that the peak in policy rates will be reached in the early months of 2023, not much higher than where rates will end 2022.
“Reflecting this view, we have reduced our longstanding underweight position in bond duration and are now back to a neutral stance,” he said. “Although government bonds have sold off hard this year, alongside risk assets, this is a typical when the interest rate cycle is in an upswing.
“As we approach the peak in rates, we expect that the correlation between government bonds and risk assets will weaken, allowing the former to regain their diversifying characteristics in multi-asset portfolios.”
While the prospect of imminent peak in interest rate expectations, against a backdrop of rapidly slowing growth, is constructive for government bonds, O’Connor said it is “good-news, bad news mix” for equities and corporate debt.
“Valuations are more attractive in these asset classes after this year’s de-rating, but they don’t yet look sufficiently cheap to provide a strong case for rebuilding exposures,” he said. “With growth downgrades likely to provide persistent headwinds for risk assets in the months ahead, we retain underweights across risk assets, although we find more reasonable value across higher-quality credit markets now.”
In broad terms, O’Connor said he would highlight two conditions that probably need to be met before Janus can get more strategically constructive on risk assets.
“One is that we get more confident that markets have priced in the peak in the interest rate cycle,” he said. “The other is that we get more confident that markets have factored in more realistic growth expectations. Capital preservation should remain a key focus until at least one of these conditions has been met.”
While being less concerned about interest rate risk than he has for most of the year, O’Connor does remain wary of the risks associated with slowing growth.
“Headline inflation has probably already peaked in the major economies but progress on core inflation, service sector inflation and wage growth will probably be the most important cyclical drivers of broad risk appetite in the months ahead,” he said. “An easing of inflation on these measures will take the pressure off central banks, interest rates and financial markets.
“Alternatively, if underlying inflation remains stronger for longer than we expect, then the bear markets in equities and bonds will probably have further to run,” he added.