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Thornburg Investment Management 2023 Outlook Global Fixed Income

Fed Policy Won’t Pivot Until Inflation Is on a Clear Downward Path

Jeff Klingelhofer, CFA
Co-Head of Investments and Managing Director
22 Dec 2022
7 min read

The yield component of fixed income is back! However, Central Bank policy rates, led by the U.S. Fed, will continue to climb until “bad” inflation is on a solid downward trend.

The top story of 2022 was central bank policy actions to combat inflation, led by the Federal Reserve, and the subsequent removal of accommodative monetary policy in response to surging price pressures. The seeds of global inflation were planted during the response to COVID, which saw unprecedented levels of government spending, especially in the United States. It’s hard to believe that as recently as March, the Federal Funds rate was at zero and the Fed was still pursuing its quantitative easing program. As a result, the Fed and other global central banks quickly fell behind the curve, putting their very credibility at risk and forcing a pivot to a hawkish policy regime.

Central Bank Credibility is Precious — And on the Line

Source: Bloomberg


Central Bank Policy Rates Will Climb Until Inflation Is on a Solid Downward Trend

Global central bank policy remains fully tethered to the broader fight to reclaim price stability. On one hand, the Fed has been aggressively raising rates and continuing the paradigm shift from a free cost of money at the start of 2022 to a very significant, real cost of money as we move into 2023. We have also witnessed scores of interest rate increases around the globe, with central banks other than the Fed having raised rates well over 100 times. This transition from the great monetary experiment of the 2010s is being felt across a wide range of markets. The impact of this fundamental change ranged from pain in emerging markets to significant selloffs in stocks across most regions. Additionally, rising U.S. policy rates led to potentially destabilizing effects of extreme dollar strength, which caused the Bank of England and the Ministry of Finance in Japan to intervene directly in currency markets.

Sovereign yield curves are currently either flat or inverted, signaling serious market concerns about the ability of central banks to steer economies away from recession. As we noted earlier, the Fed may start talk about pausing rate increases, or even cutting rates, but only after inflation is on the clear and directional path down. But how swiftly the Fed pivots depends on the contributors to inflation– that is, will they be deemed “good” (i.e., broad-based wage inflation change to focused on lower income consumer) or will they be considered “bad” (i.e., goods inflation). The Federal Reserve may be more tolerant to pivot away from their hawkish policy stance, or perhaps eventually cutting policy rates, if inflation is being more driven by (same as above) broad-based wage gains as opposed to rising goods inflation.

Valuations have become more attractive, but not overly cheap

With volatility and uncertainty comes better priced assets, and valuations certainly look improved across fixed income sectors. Spreads have risen to levels either near or modestly wider than their 10-year historic averages, and at or near the top of 12-month ranges. Given that the last 10 years has been one of broad central bank support, it doesn’t mean valuations are screamingly cheap – but they have become more compelling. We believe it makes sense to take some risk in this market, but to also have the ability to pivot into more risk should spreads resume widening and/or become dislocated. If inflation continues, yields will rise. But if recession comes, yields will fall as central banks cut rates, allowing us to build a better portfolio. From an active manager’s perspective, the curve is symmetric and creates opportunities.

Fixed Income Spreads Are above Their 10-Year Averages

Source: Bloomberg and JPMorgan


Implications of 2022 Market Moves? Yield Is back!

Although the inverted yield curve raises worries about aggressive Fed tightening tipping the U.S. economy into recession, it also stands that investors are not getting paid to go significantly out the curve. Instead, investors are actually receiving more compensation at the two to three-year segment of the curve than they are in the 10-year maturity, which has more than three-times the duration. Should the yield curve eventually become steeper and more “normally” shaped, this dynamic will change.

There Is No Additional Yield Out on the Curve

Source: Bloomberg

The silver lining is that there is some yield in the market to compensate for market uncertainties. We think this presents good relative value for actively managed portfolios that can pull many levers – given that many places within fixed income have yield now – and therefore, presenting both compelling and competing opportunities to choose from.

The Prime Consumer Balance Sheet Remains Attractive

We continue to like the prime consumer (consumers viewed by lenders as more likely to pay back their loans and less likely to default), who has remained vigilant through financial market volatility and rising inflation. That said, excess savings are coming down and at some point, consumption will have to soften, perhaps notably. While the overall consumer is strong, we are avoiding the subprime or lower credit score bands because we realize that these consumers are under the most pressure in terms of their ability to service their debt. We’ll be watching jobs numbers very closely as any decrease in employment tends to disproportionately hit lower quality borrowers. But we very much like the top of the stack prime consumers who are less vulnerable to default.

This carries over into our outlook for securitized credit. We favor prime consumer asset-backed securities and areas within non-agency mortgage credit. Within the former, we are seeing interesting opportunities in consumer lending (i.e. “Marketplace lending”) as well as in the prime auto sector. Our non-agency mortgage exposure is focused on non-qualified (non-QM) loans, for which the underlying borrowers have robust credit profiles and put large down payments on the residential properties. Within Agency mortgage-backed securities, rising rates and a risk-off tone has made valuations on certain 30-year pass-throughs very attractive. In fact, our Agency mortgage exposure provides good diversification to our consumer credit exposure, as these positions should do well in a stressed environment. Overall, we continue to believe there will be plenty of opportunity in securitized credit. A unique aspect of the securitized market is that, unlike high yield corporates, issuance must still come to market despite volatility, which is advantageous because it allows us to provide liquidity into the market and buy bonds at very attractive yields.

In the corporate bond space, yields are starting to look interesting again, and in some pockets are beginning to compensate investors for the risks in the market. On a relative basis, the investment grade market looks more appealing than the high yield space. Although spreads are notably wider in high yield versus 12 months ago, the lack of supply has kept a lid on valuations becoming even cheaper. New issuance in high yield has been extremely muted, with even high-quality issuers avoiding coming to market as they anticipate that funding costs will be unfavorable. However, investment grade issuance broadly continues, and as a result, it has put more pressure on spread levels. In credit overall, we will continue to be selective both in investment grade and high yield, preferring to take more risk only when the risk/reward tradeoff is more apparent. But this is something we will continue to watch closely.

Within emerging markets, we continue to take a cautious tone in the face of continued global risks. In many ways, emerging market economies face the same inflation and growth headwinds as their developed market counterparts. The exception are countries that are commodity exporters, in particular ones that have benefited from the rise in oil prices. Given present macro risks, issuance has been relatively muted in the emerging market debt sector and we expect that to continue headed into 2023. As always, we focus on owning issuers with strong balance sheets and attractive relative value, but we are prepared to be more tactical in this environment. With uncertainty continuing, we expect mispricings to occur, both within competing emerging markets debt issuers but also in comparison to developed market corporates, which we will continue to exploit.

Long-Term Rising Trend in Volatility Continues, Which Will Favor Active Investors

Volatility is rising and, we believe, here to stay, especially as the Fed and other central banks are no longer in the business of supporting markets the way they have since the Global Financial Crisis. Higher volatility generally favors strategies with 1) more investment flexibility, 2) a focus on downside protection, and 3) a team and process that puts a premium on quick decision-making and execution.




Central banks are laser focused on price stability and believe their aggressive policy will bring inflation directionally downward. However, the market believes this will also require weaker growth and some suppression of a so far resilient labor market.

U.S. Corporates

Overall yield levels now look reasonable, though high yield valuations are on the tighter side versus underlying risks and we are therefore cautious to add. Continue to surveil secondary market as the primary in high yield remains essentially shut down.

Securitized (ABS/RMBS)

Consumer balance sheet remains vigilant through financial market volatility and rising costs. Continue to remain cautious on subprime given this cohort is under the most pressure in the current environment.

Emerging Markets

Remain cautious given still uncertain macro picture. We believe this environment will create security-level mispricing for which we will look to exploit. Timing will be based on domestic and global trends.



Rates appear near fair value given the balance of growth and inflation risks. We continue to incrementally add or subtract duration opportunistically and in response to near-term rallies and back-ups.

U.S. Corporates

Focus on names with less cyclicality, such as utilities, select technology issuers, high-quality financials, as well as bonds that can exhibit lower spread volatility in a risk-off environment.

Securitized (ABS/RMBS)

Favor prime consumer ABS and non-agency mortgage credit. Modest exposure to specified pools within Agency MBS provides fundamental hedge to our consumer credit position should downside growth be realized.

Emerging Markets

Continued focus in areas with high real rates, advanced policy cycles, and improving domestic demand. Prepared to be a bit more tactical should valuations temporarily under or overshoot.

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