As headline inflation rates are likely to come down in the near term, tightening monetary policies from both US and European central banks are unlikely to continue into 2023, according to Invesco at a media briefing.
Nonetheless, Western central banks are more likely to overshoot in their tightening, increasing the risk of recession and keeping market volatility high.
Therefore, the US asset manager favours credit risk over equity risk in 2023, especially US investment grade bonds.
“We see the US economy likely to avoid any significant kind of recession. It is either a relatively modest economic downturn or an actual recession that is relatively shallow. In that environment, I would anticipate US investment grade to perform well,” said Kristina Hooper, chief global market strategist at Invesco.
“My expectation is that we will see inflation moderating, the Fed will stop tightening and I think the US economy will avoid prolonged recession, so US investment grade will look particularly attractive.”
Currently, investment grade bonds offer attractive yields of around 5-6%, while risky credits yield around 8-9%, according to the asset manager.
“Within fixed income, we are underweight risky credit as a contractionary regime has historically led to underperformance in high yield relative to higher quality debt with similar duration,” Hooper added.
She recommended waiting for the spread to widen further in the high yield space before increasing exposure.
Although they do offer opportunities, the other area which Hooper is less positive on is European and UK investment grade bonds due to the fear of a deeper recession.
On the other hand, due to the possibility of further weakness in growth, Invesco is less positive on the prospect of equities.
During next year’s expected contraction, Invesco prefers investing in developed markets over emerging markets and favours large cap quality companies.
It also believes consumer staples and healthcare names will outperform other sectors.
Yet, Invesco believes as monetary tightening pauses and the economy recovers, investors’ asset allocation should reverse to favour emerging markets and small and mid-caps companies.
