Menu Our services in the selected location:
  • No services available for your region.
Select Location:
Remember my selection
Your browser is out of date.

AWAITING PEAK HAWKISHNESS

Fixed Income Outlook 4Q 2022

October 11, 2022  |  8 Minute Read


Samuel Finkelstein

Chief Investment Officer, Fixed Income and Liquidity Solutions

Samuel Finkelstein

Whitney Watson

Global Head of Fixed Income Portfolio Management, Construction & Risk

Whitney Watson


 

Fixed Income Perspectives

 

Inflation has remained elevated and the broader economic environment—most notably the labor market—has proved resilient. As a result, central banks remain on a hiking path, with policy rates expected to rise to a higher level than anticipated last quarter. The risk is that they go too far too fast, given that monetary policy impacts the economy with a lag. We think stabilization in markets will require evidence of a peak in inflation, a peak in policy hawkishness and a peak in real yields. Near-term risks are tilted towards another wave of tightening in global financial conditions and the path to peak hawkishness will be challenging, particularly as recession risks rise. As a result, we enter the fourth quarter in a defensive position, remaining overweight the US dollar, while favoring higher quality and less growth-sensitive sectors such as investment grade corporate credit and agency mortgage-backed securities (MBS). 

 

 

”Valuations have reset lower but rising real yields remain a headwind. Once we have clearer evidence of a peak in inflation—and in turn policy tightening and real yields—we think the current risk premiums will create an alpha tailwind for active investors.”

- Sam Finkelstein

 

”Higher inflation and higher growth volatility are propelling us into a higher yield environment, marking a departure from the post-financial crisis era. Ultimately, we think this presents opportunities in high-quality fixed income assets, such as investment grade corporate bonds and agency MBS.”

- Whitney Watson

 


 

Macro at a Glance

 

Growth

As discussed in our Fixed Income 3Q Outlook:  Navigating Expeditious Tightening, a soft landing requires policymakers to slow growth to below potential to loosen the labor market enough to temper wage growth and inflation. Heading into the fourth quarter, the persistence of inflation and continued policy tightening raises the risk of recession. Europe faces the added challenge of energy supply and cost issues, while China looks set to grow just 3% this year, owing to weakness in the property sector and ongoing Covid-related activity restrictions. In the UK, growth support from fiscal easing is somewhat offset by the need for further policy tightening.

 

 

Tight Labor Markets are Driven by Both Supply Issues and High Demand

 

Source: Goldman Sachs Global Investment Research. As of September 6, 2022.

 

Inflation

In line with our expectations, goods inflation is moderating due to normalizing demand, easing supply chain issues and lower commodity prices. However, services inflation such as rents remains firm, particularly in the US. UK inflation will likely peak at a lower level, owing to the energy price cap, while Euro area inflation continues to surprise on the upside, reaching new all-time highs in August. We are closely monitoring labor markets for signs of loosening and evidence of easing inflation pressures across both core goods and core services as the impact of policy tightening begins to take hold.

 

 

Easing Supply Chain Issues Offer Some Relief to Goods Inflation

 

Source: Macrobond, Markit, Goldman Sachs Asset Management. As of August 2022.

 


 

Policy Picture

 

Monetary

Our outlook for major central banks has reset in a hawkish direction yet again. The Fed has signalled a further 125bps of rate increases by the end of the year, European Central Bank (ECB) communications have turned increasingly hawkish, and the Bank of England (BoE) looks set to accelerate its pace of tightening given upside risks posed by currency weakness and proposed fiscal stimulus. Even the Bank of Japan (BoJ), a notable dovish outlier, could retrench from ultra-easy policies such as yield curve control in the coming months. Insofar as higher Japanese government bond yields motivate repatriation of Japanese investor capital, global term premium may face a fresh upward impulse.1 

 

 

Central Banks Continue to Climb Rate Hiking Cycles

 

Source: Macrobond, Goldman Sachs Asset Management. As of October 1, 2022.

 

Fiscal

European governments have intervened to shelter households (and to a lesser degree firms) from high energy prices. Euro area measures amount to around 2.5% of GDP, with additional support likely to come from spending linked to revenue received from windfall taxes.2 The UK has announced large-scale tax cuts in addition to a two-year cap on household energy prices. The measures may support growth and lower the peak in headline inflation but imply upside risks to core inflation, complicating the BoE’s task of taming inflation. Notably, UK and EU interventions still imply higher energy costs relative to a year earlier, suggesting some degree of demand destruction over the winter.

 

 

UK Fiscal Easing and Currency Weakness Raises Inflation Risks

 

Source: Macrobond, Goldman Sachs Asset Management. As of August 2022.

 


 

Navigating Fixed Income

 

Fixed Income Spread Sectors

 

Asset Allocation: Although valuations have reset lower since the summer relief rally, the road to peak hawkishness will likely be challenging for most financial assets, particularly as recession risks rise. As a result, our asset allocation across spread sectors is defensive and up-in-quality. Specifically, we see value in investment grade corporate bonds and agency MBS given their lower sensitivity to growth weakness and our view that spreads are wide relative to underlying fundamentals. 

 

Portfolio Balance: In a high inflation environment, a “balanced portfolio” that combines exposure to spread sectors with interest rates can lose its balance as the rates-credit correlation turns less negative or even positive. Considering this, we are no longer balancing fixed income portfolios with interest rates.

 

EM Spotlight: In our view, EM corporate debt is a bright spot in the EM universe. Companies display strong fundamentals, and their bonds offer an attractive yield premium over comparable rated DM peers. The departure of challenged issuers—largely from the China property sector and Russia—has improved the quality of the sector’s benchmark and EM companies have displayed credit resilience even in the face of sovereign level credit stress. The sector also offers attractive alpha potential for active investors due to investor segmentation and lower research coverage relative to other asset classes.

 

 

Macro Markets

 

We remain overweight the US dollar given it is a beneficiary of both Fed tightening and recession concerns. Elsewhere, we hold moderate exposure to DM sovereign bonds as the current environment of high inflation, relatively flat yield curves and synchronized central bank tightening limits both the directional and relative value opportunity set. That said, we are underweight Japanese rates as we think a combination of reduced deflation risks, global pressures and currency weakness could prompt the BoJ to begin to depart from its ultra-easy monetary policies. 

 

 

High Quality Fixed Income Spreads Appear Wide Relative to Fundamentals

 

Source: Macrobond, Goldman Sachs Asset Management, ICE BofAML Indexes. As of September 29, 2022.

 


 

Sustainability Spotlight

 

Europe’s New Energy Reality

 

Near-Term Challenges: Limited long-term gas contracts and reliance on Russia has left Europe vulnerable to soaring natural gas prices. As highlighted in our weekly MusinGS (September 9 and July 15), the near-term response has entailed a degree of demand destruction, supply substitution (including delayed closure of coal plants and nuclear reactors), rising storage reserves, energy price caps and targeted support for corporates. Near-term risks to supply and gas prices include a colder-than-average winter, higher China demand and an escalation in geopolitical tensions.

 

 

 

Longer-Term Opportunity: Europe has an opportunity to leverage the current challenges to build a more sustainable energy system for the future, improving energy affordability, the region’s balance of payments, security of supply and creating domestic employment in key clean tech innovation areas.5 Globally, clean energy jobs already account for more than half of employment in the energy sector6 and the European Union’s REPowerEU program, which places emphasis on energy efficiency targets, will likely drive up demand for highly-skilled clean energy workers in the region. For fixed income investors, as noted in Europe Recovering Into A New Regime, positive yields and structural reform focused on energy transition and digitization may offer bottom-up corporate bond opportunities, particularly in green bonds issued to strengthen resilience to physical climate risks, and accelerate the energy transition.

 

 

A Cold Winter Could Still Present Challenges Despite High Gas Storage

 

Source: Macrobond, Goldman Sachs Asset Management, European Commission (EC), Gas Infrastructure Europe. As of September 2022.

 


 

 

 

 

Related Insights

Start the Conversation

Committed to providing you with the insights you need to build your practice.

 

1. Goldman Sachs Global Investment Research – European Views: More Hikes into Recession. As of September 26, 2022.

2. Goldman Sachs Global Investment Research – European Views: More Hikes into Recession. As of September 26, 2022.

3. Goldman Sachs Global Investment Research Carbonomics: Re-Imagining Europe’s Energy System. As of July 21, 2022.

4. Goldman Sachs Global Investment Research Carbonomics: Re-Imagining Europe’s Energy System. As of July 21, 2022.

5. UBS call with James Henderson and Mike Fulwood, experts on Natural Gas at the Oxford Institute of Energy Studies. 

6. International Energy Agency World Energy Employment Report published in September 2022 and based on 2019 employment statistics. 

7. International Energy Agency World Energy Employment Report published in September 2022 and based on 2019 employment statistics. 

Source: As of October 11, 2022. The economic and market forecasts presented herein are for informational purposes as of the date of this document. There can be no assurance that the forecasts will be achieved.

Abbreviations: US Federal Reserve (Fed), European Central Bank (ECB), Bank of England (BoE), developed markets (DM), emerging markets (EM), Bank of Japan (BoJ). 

Disclosures

Views and opinions expressed are for informational purposes only and do not constitute a recommendation by GSAM to buy, sell, or hold any security. Views and opinions are current as of the date of this document and may be subject to change, they should not be construed as investment advice.

Investment Grade (IG) refers to the quality of a company's credit and to be considered investment grade issue, a company must be rated at 'BBB' or higher. Anything below this 'BBB' rating is considered non-investment grade or high yield.

This material is provided at your request for informational and educational purposes only. It is not an offer or solicitation to buy or sell any securities.

THIS MATERIAL DOES NOT CONSTITUTE AN OFFER OR SOLICITATION IN ANY JURISDICTION WHERE OR TO ANY PERSON TO WHOM IT WOULD BE UNAUTHORIZED OR UNLAWFUL TO DO SO.

Prospective investors should inform themselves as to any applicable legal requirements and taxation and exchange control regulations in the countries of their citizenship, residence or domicile which might be relevant.

This information discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice. This material has been prepared by GSAM and is not financial research nor a product of Goldman Sachs Global Investment Research (GIR). It was not prepared in compliance with applicable provisions of law designed to promote the independence of financial analysis and is not subject to a prohibition on trading following the distribution of financial research. The views and opinions expressed may differ from those of Goldman Sachs Global Investment Research or other departments or divisions of Goldman Sachs and its affiliates. Investors are urged to consult with their financial advisors before buying or selling any securities. This information may not be current and GSAM has no obligation to provide any updates or changes.

United Kingdom: In the United Kingdom, this material is a financial promotion and has been approved by Goldman Sachs Asset Management International, which is authorized and regulated in the United Kingdom by the Financial Conduct Authority.

European Economic Area (EEA): This material is a financial promotion disseminated by Goldman Sachs Bank Europe SE, including through its authorised branches ("GSBE"). GSBE is a credit institution incorporated in Germany and, within the Single Supervisory Mechanism established between those Member States of the European Union whose official currency is the Euro, subject to direct prudential supervision by the European Central Bank and in other respects supervised by German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufischt, BaFin) and Deutsche Bundesbank.

Switzerland: For Qualified Investor use only – Not for distribution to general public. This is marketing material. This document is provided to you by Goldman Sachs Bank AG, Zürich. Any future contractual relationships will be entered into with affiliates of Goldman Sachs Bank AG, which are domiciled outside of Switzerland. We would like to remind you that foreign (Non-Swiss) legal and regulatory systems may not provide the same level of protection in relation to client confidentiality and data protection as offered to you by Swiss law.

Asia Pacific: Please note that neither Goldman Sachs Asset Management International nor any other entities involved in the Goldman Sachs Asset Management (GSAM) business maintain any licenses, authorizations or registrations in Asia (other than Japan), except that it conducts businesses (subject to applicable local regulations) in and from the following jurisdictions: Hong Kong, Singapore and Malaysia. This material has been issued for use in or from Hong Kong by Goldman Sachs Asset Management (Hong Kong) Limited, in or from Singapore by Goldman Sachs Asset Management (Singapore) Pte. Ltd. (Company Number: 201329851H) and in or from Malaysia by Goldman Sachs (Malaysia) Sdn Berhad (880767W).

Australia: This material is distributed by Goldman Sachs Asset Management Australia Pty Ltd ABN 41 006 099 681, AFSL 228948 (‘GSAMA’) and is intended for viewing only by wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth). This document may not be distributed to retail clients in Australia (as that term is defined in the Corporations Act 2001 (Cth)) or to the general public. This document may not be reproduced or distributed to any person without the prior consent of GSAMA. To the extent that this document contains any statement which may be considered to be financial product advice in Australia under the Corporations Act 2001 (Cth), that advice is intended to be given to the intended recipient of this document only, being a wholesale client for the purposes of the Corporations Act 2001 (Cth). Any advice provided in this document is provided by either GoldmanSachs Asset Management International (GSAMI), Goldman Sachs International (GSI), Goldman Sachs Asset Management, LP (GSAMLP) or Goldman Sachs & Co. LLC (GSCo). Both GSCo and GSAMLP are regulated by the US Securities and Exchange Commission under US laws, which differ from Australian laws. Both GSI and GSAMI are regulated by the Financial Conduct Authority and GSI is authorized by the Prudential Regulation Authority under UK laws, which differ from Australian laws. GSI, GSAMI, GSCo, and GSAMLP are all exempt from the requirement to hold an Australian financial services licence under the Corporations Act of Australia and therefore do not hold any Australian Financial Services Licences. Any financial services given to any person by GSI, GSAMI, GSCo or GSAMLP by distributing this document in Australia are provided to such persons pursuant to ASIC Class Orders 03/1099 and 03/1100. No offer to acquire any interest in a fund or a financial product is being made to you in this document. If the interests or financial products do become available in the future, the offer may be arranged by GSAMA in accordance with section 911A(2)(b) of the Corporations Act. GSAMA holds Australian Financial Services Licence No. 228948. Any offer will only be made in circumstances where disclosure is not required under Part 6D.2 of the Corporations Act or a product disclosure statement is not required to be given under Part 7.9 of the Corporations Act (as relevant).

Canada: This document has been communicated in Canada by GSAM LP, which is registered as a portfolio manager under securities legislation in all provinces of Canada and as a commodity trading manager under the commodity futures legislation of Ontario and as a derivatives adviser under the derivatives legislation of Quebec. GSAM LP is not registered to provide investment advisory or portfolio management services in respect of exchange-traded futures or options contracts in Manitoba and is not offering to provide such investment advisory or portfolio management services in Manitoba by delivery of this material.

Japan: This material has been issued or approved in Japan for the use of professional investors defined in Article 2 paragraph (31) of the Financial Instruments and Exchange Law by Goldman Sachs Asset Management Co., Ltd.

Emerging markets securities may be less liquid and more volatile and are subject to a number of additional risks, including but not limited to currency fluctuations and political instability. 

Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. 

References to indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only and do not imply that the portfolio will achieve similar results. The index composition may not reflect the manner in which a portfolio is constructed. While an adviser seeks to design a portfolio which reflects appropriate risk and return features, portfolio characteristics may deviate from those of the benchmark.

Bahrain: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

This material has not been reviewed by the Central Bank of Bahrain (CBB) and the CBB takes no responsibility for the accuracy of the statements or the information contained herein, or for the performance of the securities or related investment, nor shall the CBB have any liability to any person for damage or loss resulting from reliance on any statement or information contained herein. This material will not be issued, passed to, or made available to the public generally.

Egypt: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

The securities discussed in the enclosed materials are not being offered or sold publicly in Egypt and they have not been and will not be registered with the Egyptian National Financial Supervisory Authority and may not be offered or sold to the public in Egypt. No offer, sale or delivery of such securities, or distribution of any prospectus relating thereto, may be made in or from Egypt except in compliance with any applicable Egypt laws and regulations.

Oman: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

The Capital Market Authority of the Sultanate of Oman (the "CMA") is not liable for the correctness or adequacy of information provided in this document or for identifying whether or not the services contemplated within this document are appropriate investment for a potential investor. The CMA shall also not be liable for any damage or loss resulting from reliance placed on the document.

Qatar: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

This document has not been, and will not be, registered with or reviewed or approved by the Qatar Financial Markets Authority, the Qatar Financial Centre Regulatory Authority or Qatar Central Bank and may not be publicly distributed. It is not for general circulation in the State of Qatar and may not be reproduced or used for any other purpose.

Saudi-Arabia: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

The Capital Market Authority does not make any representation as to the accuracy or completeness of this document, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of this document. If you do not understand the contents of this document you should consult an authorised financial adviser.

FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

These materials are presented to you by Goldman Sachs Saudi Arabia Company ("GSSA"). GSSA is authorised and regulated by the Capital Market Authority (“CMA”) in the Kingdom of Saudi Arabia. GSSA is subject to relevant CMA rules and guidance, details of which can be found on the CMA’s website at www.cma.org.sa.

The CMA does not make any representation as to the accuracy or completeness of these materials, and expressly disclaims any liability whatsoever for any loss arising from, or incurred in reliance upon, any part of these materials. If you do not understand the contents of these materials, you should consult an authorised financial adviser.

United Arab Emirates: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

This document has not been approved by, or filed with the Central Bank of the United Arab Emirates or the Securities and Commodities Authority. If you do not understand the contents of this document, you should consult with a financial advisor.

Israel: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

This document has not been, and will not be, registered with or reviewed or approved by the Israel Securities Authority (ISA”). It is not for general circulation in Israel and may not be reproduced or used for any other purpose. Goldman Sachs Asset Management International is not licensed to provide investment advisory or management services in Israel.

Kuwait: FOR INFORMATION ONLY – NOT FOR WIDER DISTRIBUTION

This material has not been approved for distribution in the State of Kuwait by the Ministry of Commerce and Industry or the Central Bank of Kuwait or any other relevant Kuwaiti government agency. The distribution of this material is, therefore, restricted in accordance with law no. 31 of 1990 and law no. 7 of 2010, as amended. No private or public offering of securities is being made in the State of Kuwait, and no agreement relating to the sale of any securities will be concluded in the State of Kuwait. No marketing, solicitation or inducement activities are being used to offer or market securities in the State of Kuwait.

South Africa: Goldman Sachs Asset Management International is authorised by the Financial Services Board of South Africa as a financial services provider.

Brazil: These materials are provided at your request and solely for your information, and in no way constitutes an offer, solicitation, advertisement or advice of, or in relation to, any securities, funds, or products by any of Goldman Sachs affiliates in Brazil or in any jurisdiction in which such activity is unlawful or unauthorized, or to any person to whom it is unlawful or unauthorized. This document has not been delivered for registration to the relevant regulators or financial supervisory bodies in Brazil, such as the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) nor has its content been reviewed or approved by any such regulators or financial supervisory bodies. The securities, funds, or products described in this document have not been registered with the relevant regulators or financial supervisory bodies in Brazil, such as the CVM, nor have been submitted for approval by any such regulators or financial supervisory bodies. The recipient undertakes to keep these materials as well as the information contained herein as confidential and not to circulate them to any third party.

Colombia: Esta presentación no tiene el propósito o el efecto de iniciar, directa o indirectamente, la adquisición de un producto a prestación de un servicio por parte de Goldman Sachs Asset Management a residentes colombianos. Los productos y/o servicios de Goldman Sachs Asset Management no podrán ser ofrecidos ni promocionados en Colombia o a residentes Colombianos a menos que dicha oferta y promoción se lleve a cabo en cumplimiento del Decreto 2555 de 2010 y las otras reglas y regulaciones aplicables en materia de promoción de productos y/o servicios financieros y /o del mercado de valores en Colombia o a residentes colombianos. 

Al recibir esta presentación, y en caso que se decida contactar a Goldman Sachs Asset Management, cada destinatario residente en Colombia reconoce y acepta que ha contactado a Goldman Sachs Asset Management por su propia iniciativa y no como resultado de cualquier promoción o publicidad por parte de Goldman Sachs Asset Management o cualquiera de sus agentes o representantes. Los residentes colombianos reconocen que (1) la recepción de esta presentación no constituye una solicitud de los productos y/o servicios de Goldman Sachs Asset Management, y (2) que no están recibiendo ninguna oferta o promoción directa o indirecta de productos y/o servicios financieros y/o del mercado de valores por parte de Goldman Sachs Asset Management. 

Esta presentación es estrictamente privada y confidencial, y no podrá ser reproducida o utilizada para cualquier propósito diferente a la evaluación de una inversión potencial en los productos de Goldman Sachs Asset Management o la contratación de sus servicios por parte del destinatario de esta presentación, no podrá ser proporcionada a una persona diferente del destinatario de esta presentación.” 

Index Benchmarks 

Indices are unmanaged. The figures for the index reflect the reinvestment of all income or dividends, as applicable, but do not reflect the deduction of any fees or expenses which would reduce returns. Investors cannot invest directly in indices. 

The indices referenced herein have been selected because they are well known, easily recognized by investors, and reflect those indices that the Investment Manager believes, in part based on industry practice, provide a suitable benchmark against which to evaluate the investment or broader market described herein. The exclusion of “failed” or closed hedge funds may mean that each index overstates the performance of hedge funds generally.

Past performance does not guarantee future results, which may vary. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur. 

Confidentiality 

No part of this material may, without Goldman Sachs Asset Management’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient. 

Date of first use: October 10, 2022. 293677-OTU-1678829.

Please enter your email address to continue reading.

Confirm Your Access


An email has been sent to you to verify ownership of your email address.

Please verify the link in the email by clicking the confirmation button. Once completed, you will gain instant access to our insights.

If you did not receive the email from us please check your spam folder or try again.