Rufaro Chiriseri, head of fixed income for the British Isles at RBC Wealth Management, outlines her 2024 outlook for UK and European fixed income. 

Rufaro Chiriseri at RBC Wealth Management believes that there are opportunities in fixed income going into 2024, as well as in European fixed income, despite the cloudy macroeconomic outlook.

Chiriseri believes that subdued economic growth and persistent inflation suggest that the UK may fall victim to stagflation in 2024, if the labour market deteriorates further. The Bank of England is unlikely to be willing to cut interest rates before the second half of the year, in her view.

Despite the unpalatable macroeconomic backdrop, she sees opportunities for investors, and she has a bias for UK bonds, adding further to gilts and increasing duration in the near term.

Credit markets held up better than RBC expected in 2023, but it is not clear to her how much longer this “goldilocks” period will last. On a one-year basis credit spreads look wider, but they are nearer to fair value over a five-year period. Consequently, the risks that spreads will widen are still high, in her view. Corporate default rates remain low, but credit fundamentals are worsening. Non-financial issuers’ debt leverage ratios have increased due to weaker corporate earnings. Furthermore, higher interest rates have led interest coverage – the measure of how many times a company’s earnings can pay interest costs – to also worsen.

Nevertheless, Chiriseri sees pockets of opportunity in non-cyclical issuers, as well as opportunities in senior-ranking bank bonds. She remains cautious and favours higher quality, short-duration investment-grade bonds over high-yield bonds as the balance of risks is tilted to the downside.

A barbell approach presents the most attractive opportunities, in her view, as she would balance risks in corporate credit with higher-quality allocations in government bonds.

European fixed income
Chiriseri believes that the risk of a recession in the eurozone has increased but opportunities exist in fixed income, beyond the cloudy macroeconomic outlook.

Credit markets have been resilient despite quantitative tightening and the European Central Bank holding nearly 33 per cent of the eligible corporate bond universe, she said. However, if the pace of corporate bond reduction increases, spreads could widen. On a one-year basis, credit spreads look wider, but nearer fair value over a five-year period. While spreads look compelling, she is loath to chase these levels as higher financing costs as well as lower corporate earnings are impairing corporates’ fundamentals, she added.

Chiriseri therefore remains cautions and maintains her up-in-quality bias, preferring investment-grade over high-yield credit for now. The yield compensation for interest rate risk in high-yield versus investment-grade debt has narrowed meaningfully and is close to decade lows. Therefore, on a risk-reward basis, she favours investment-grade bonds given the recession risks. However, she acknowledges the likelihood of an opportunity to allocate to high yield when spreads meaningfully widen.

Chiriseri believes that the goal for 2024 is to remain selective and defensive, focusing on issuer fundamentals. In particular, she favours non-cyclical over cyclical issuers, senior ranking bonds issued by banks, the utilities sector, and the telecommunication services industry.