2023 Global Market Outlook
The Return of Yield
Theme Three
Andrew McCormick, Head of Global Fixed Income and Chief Investment Officer
Sébastien Page, CFA, Head of Global Multi‑Asset and Chief Investment Officer
Justin Thomson, Head of International Equity and Chief Investment Officer

A brutal year for bond markets in 2022 ended with a silver lining for investors: It raised fixed income yields to some of the most attractive levels seen since the global financial crisis.

Higher yields (Figure 4, left) were mirrored in greatly improved valuations for both sovereigns and private credits, with many sectors selling close to or below their 15‑year historical medians as of late November (Figure 4, right). 

Higher‑quality credits in the mortgage-backed and asset‑backed sectors also are attracting inflows from investors looking to put cash to work or extend duration (a measure of interest rate sensitivity), McCormick adds.

“This is the first opportunity to try to lock in high‑single‑digit yields in well over a decade,” McCormick says. “Anytime there’s been a glimmer that the Fed might be ready to slow its pace, or that inflation might have peaked, we’ve seen money find its way into the market.”

High yield bonds could offer particularly attractive return opportunities in 2023, McCormick and Page both say. Page cites three potential positives: 

  • Credit spreads—the yield difference between private credits and comparable U.S. Treasury maturities—have widened while default rates have remained relatively low.
  • Corporate balance sheets generally are in strong shape.
  • Energy issuers account for a smaller share of U.S. high yield debt than in the past, helping reduce default sensitivity.

Default rates almost certainly will rise if the U.S. economy slips into recession, Page acknowledges. But it would take a substantial leap to offset the return advantage built into current spreads. “If we get anything outside of a deep recession, the valuation case for U.S. high yield appears pretty strong,” he argues. 

As of late November, McCormick adds, T. Rowe Price credit analysts estimated that U.S. default rates could rise to slightly under 3% for high yield bonds and just over 3% for floating rate bank loans in 2023, significantly less than current credit spreads.1 This forecast assumes that the U.S. economy passes through a mild recession, McCormick adds.

The outlook for European high yield is more guarded, McCormick says. While yields have improved there, the value proposition is less compelling because of the economic backdrop, he says.

The Bond Bear Market Has Improved Both Yields and Relative Valuations

(Fig. 4) Yields on Aggregate Bond and High Yield Indexes; Fixed Income Valuations vs. Historical Averages

Yields on Aggregate Bond and High Yield Indexes; Fixed Income Valuations vs. Historical Averages

Yields as of November 25, 2022. Valuations as of November 30, 2022. Subject to change.
Past performance is not a reliable indicator of future performance.
*U.S. Treasury = 10‑Year Note, German Bund = 10‑Year Bund, UK = 10‑Year Gilt, JGB = 10‑Year Japanese Government Bond, U.S. IG Corp.= Bloomberg U.S.
Investment Grade Corporate Index, Europe IG Corp. = Bloomberg EuroAggregate Credit Index, U.S. High Yield = Bloomberg U.S. Aggregate Credit–Corporate High Yield Index, Global High Yield = Bloomberg Global High Yield Index, Emerging Markets Debt = Bloomberg Emerging Markets USD Aggregate Index.
Sources: Bloomberg Financial L.P. and Bloomberg Index Services Limited (see Additional Disclosures). T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved.

Illiquid Markets Could Be Volatile

Market liquidity deteriorated in 2022 as monetary tightening accelerated, McCormick notes. As central banks shrink their balance sheets in 2023, new buyers will be needed. But stricter capital rules put in place after the global financial crisis have made it harder for bond dealers to function as liquidity providers.

“We’ve already seen bouts of illiquidity in some high‑quality markets, like UK gilts and U.S. Treasuries,” McCormick notes. “We believe the risk of further episodes remains elevated.”

"We’ve already seen bouts of illiquidity in some high‑quality markets....We believe the risk of further episodes remains elevated."
— Andrew McCormick, Head of Global Fixed Income and Chief Investment Officer

But poor liquidity and price volatility also can create opportunities for longer‑term investors, McCormick notes. The U.S. municipal bond market, for example, experienced several months of outflows in late 2022 as investors harvested tax losses and repositioned for higher rates. 

Credit conditions in the muni market appear strong, McCormick says. State and city governments received federal support during the pandemic shutdown, he notes, and saw tax revenues rise when businesses reopened. Given these fundamentals, muni yields and spreads remained attractive by most historical standards as of late November, which was attracting buyers back to the market.

Diversification in an Inflationary World

Higher volatility also has big implications for portfolio construction, Page says. But the key issue is the source of that volatility and its impact on asset correlations. 

Historically, Page says, returns on stocks and on U.S. Treasuries have tended to move in the same direction when worries about inflation and interest rates were high—as they were in 2022. This can destroy the diversification benefits of Treasuries. But, when concerns about economic growth are uppermost, returns can move in opposite directions, increasing the diversification benefits of Treasuries.

If 2023 is dominated by concerns about growth, Treasuries could resume their traditional role as portfolio diversifiers, Page predicts. But, over the longer run, he says, different tools may be needed. These could include:

  • “Barbell” structures that divide bond allocations between long Treasuries and fixed income diversifiers such as high yield, floating rate, and EM debt.
  • Alternative strategies that seek to deliver positive absolute returns.
  • Real assets equities, such as energy, real estate, and metals and mining stocks.
  • Equity strategies that potentially offer downside risk mitigation in inflationary environments when Treasuries fail.
The Return of Yield
Investment IdeaRationaleExamples
Bond Yields Are More AttractiveHigher interest rates and wider credit spreads have lifted yields in many fixed income sectors. While a slowing economy could further widen spreads, current yield levels can help provide a buffer against a rise in default rates.- High Yield Bonds
- Municipal Bonds

For illustrative purposes only. This is not intended to be investment advice or a recommendation to take any particular investment action. Diversification cannot assure a profit or protect against loss in a declining market.

1 Actual future outcomes may differ materially from estimates.

Appendix Disclosures

Past results are not a reliable indicator of future results. Index performance is for illustrative purposes only and is not indicative of any specific investment. Their performance does not reflect fees and expenses associated with an actual investment. Investors cannot invest directly in an index. Actual investment results may differ materially.

US Stock returns were based on daily S&P 500 Index total returns from January 3, 1928, through July 31, 2022. Fixed income returns were based on an estimate of daily interpolated returns for the Ibbotson Intermediate Government Bond Index from January 3, 1928, through December 29, 1961, and on daily total returns for the 5‑year U.S. Treasury note where daily data were available from January 2, 1962, through July 31, 2022. High inflation and rising rate environments were determined using CPI and 10-year treasury yields.

Additional Disclosures

Information has been obtained from sources believed to be reliable but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2022, J.P. Morgan Chase & Co. All rights reserved.

Copyright © 2022, Markit Economics Limited now part of S&P Global. All rights reserved and all intellectual property rights retained by S&P Global.

“Bloomberg®” and Bloomberg U.S. Investment Grade Corporate Index, Bloomberg EuroAggregate Credit Index, Bloomberg U.S. Aggregate Credit–Corporate High Yield Index, Bloomberg Global High Yield Index, and Bloomberg Emerging Markets USD Aggregate Index are service marks of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”), the administrator of the index (collectively, “Bloomberg”) and have been licensed for use for certain purposes by T. Rowe Price. Bloomberg is not affiliated with T. Rowe Price, and Bloomberg does not approve, endorse, review, or recommend T. Rowe Price products. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to T. Rowe Price products.

The “S&P 500 Index” is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”), and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by T. Rowe Price. T. Rowe Price products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.

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Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of December 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Investment Risks:
International investments
can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. Small‑cap stocks have generally been more volatile in price than the large‑cap stocks. The value approach to investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. Growth stocks are subject to the volatility inherent in common stock investing, and their share price may fluctuate more than that of a income‑oriented stocks. Sustainable investing may not succeed in generating a positive environmental and/or social impact. Real estate is affected by general economic conditions. When growth is slowing, demand for property decreases and prices may decline. Active investing may have higher costs than passive investing and may underperform the broad market with similar objectives. Alternative investments may involve a high degree of risk, may undertake more use of leverage and derivatives, and are not suitable for all investors. Fixed‑income securities are subject to credit risk, liquidity risk, call risk, and interest‑rate risk. As interest rates rise, bond prices generally fall. Investments in high‑yield bonds involve greater risk of price volatility, illiquidity, and default than higher‑rated debt securities. Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. Commodities are subject to increased risks such as higher price volatility, geopolitical and other risks. Derivatives may be riskier or more volatile than other types of investments because they are generally more sensitive to changes in market or economic conditions. Risks include currency risk, leverage risk, liquidity risk, index risk, pricing risk, and counterparty risk. Diversification cannot assure a profit or protect against loss in a declining market. There is no assurance that any investment objective will be met.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Actual outcomes may differ materially from any forward-looking statements made. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc.

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