Our Christmas Shopping List (and some 2023 Prognostications)

Rick Rieder and team outline how to think about portfolios as we enter 2023.

1 or more years of additional interest-rate duration in ‘23 vs. ‘22, to be grown over time: As central banks slow, or pause, their tightening cycles, in sympathy with slowing economic growth and inflation.

2 years of locked-up returns in fixed income assets, at a generational inflection point in yields: A decline in inflation volatility suggests a decline in interest rate volatility too, both from extreme levels.

3 -handle inflation by the end of 2023, driving a decline in rate volatility: Oil’s falling price means it is becoming a deflationary impulse, and leading indicators for housing suggest a correction is in motion (the highest-beta and largest components of CPI, respectively).

4 more months (or less) of data/policy uncertainty, after which the Fed can pause: The market has fully priced in another 100 basis points (bps) of hikes over the next four months.

5 years of runway potential for fixed income to generate outsized returns: The higher we climb up the discount rate mountain, the more vertical is created on the other side.

6% to 6.5% of portfolio carry potential (including anticipated curve rolldown): Without needing to take on much duration, credit, convexity or illiquidity risks.

7% carry (including rolldown) potential in U.S. Investment-Grade: Based on historical returns, at similar entry yields.

8 or a high single digit number of significant defaults in 2023: We have probably left the 1% default rate in high yield behind us, but we don’t anticipate seeing 2009’s 13% either.

9% nominal GDP may be behind us, but we won’t dip much below 4% NGDP (while the 7 years before the pandemic averaged 3%): The strong labor market will keep real growth from collapsing, even as inflation slows.

10% potential return on mortgages, if yields just went back to the 83^rd percentile from over the last 10 years (from the 98th percentile, currently): Supported by shelter inflation that is slowing, but a housing market that is not going into a bust.

11% carry (including rolldown) potential in U.S. High Yield, for those able to venture into the right places: Keeping in mind that defaults will probably rise off record lows, making selectivity critical.

12 months of carry in fixed income hasn’t been this exciting in many, many years!

…and a bunch of equity gamma, funded by a portion of that fixed income carry, to capture the potential for right-tail risk.