2022 will be all about bonds. We will see interest rates rising, provoking an increase in market volatility. While dropping yields have supported the economy and assets valuations for years, rising yields will threaten weaker companies and growth.
Despite the turmoil in markets, central banks will not have a choice other than to tighten the economy to slow down price pressures. Aggressive monetary policies will put upward pressure on the front part of the yield curve. In contrast, long-term yields will remain compressed as the economy decelerates. Therefore, the US yield curve will bear-flatten throughout the year. Yet, it’s real yields investors should pay attention to. As the Federal Reserve adjusts its tightening path, inflation expectations will adjust lower while nominal yields will move higher, accelerating the rise in real yields.
The only way to find shelter from high inflation and rising interest rates is to look at yield above the expected inflation rate while minimizing duration exposure. Only junk bond space can offer a solution to the problem. However, at this moment, it is critical to cherry-pick credits under a buy-to-hold perspective not to incur a capital loss. Don’t worry, though! Although higher rates will be distressing for risky assets, more exciting opportunities will emerge.