On January 9th, DWS Global Investment Management released a report stating that looking ahead to 2024 and the prospect of a significant slowdown in economic activity, the institution believes that sovereign fixed income (especially US Treasuries) is becoming increasingly attractive to investors in the medium term. Like some other asset classes, the institution expects volatility to continue in the near term. The seemingly strong momentum of the US labor market and its impact on Federal Reserve policy has been (and is likely to continue to be) a concerning factor. At the same time, as the pillars of economic slowdown and long-term demographic structure begin to strengthen, positive factors are accruing. Focus on sovereign bonds Most major central banks have raised policy rates at the most aggressive pace in decades. However, the response to this aggressive policy is well known to take a long time to transmit and is subject to changes. Therefore, the institution can expect that the inevitable economic slowdown has not been influenced by recent rate hikes. Meanwhile, deflationary dynamics are expected to persist for some time. This policy-driven cycle favors longer maturity allocations in sovereign bonds as lower rates and a steepening yield curve will eventually reflect in prices. The institution believes that the US Treasury market is the most straightforward way to capture these market pricing changes. In addition to cyclical factors, long-term demographic trends also support the institution's bullish outlook on bonds. Sluggish labor and productivity growth in the US underscore the fundamental long-term value of real yields in major sovereign debt markets. Outside the US, the situation may be slightly different. For example, in major European markets, core inflation remains stubbornly high, or there are signs of sticky inflation; more worrisome is that rising energy costs are likely to impact overall inflation. The strengthening of the US dollar further exacerbates these issues. Although markets may ease rates earlier than currently implied or even more aggressively than central bank rhetoric suggests, there are still risks: inflation becomes more difficult to address, and Eurozone and other European sovereign bond investors are likely to remain cautious until they can devise more decisive measures to counter deflationary dynamics. Credit preparation ready While investment-grade corporate credit has benefited from relatively robust fundamentals, the institution expects that corporate credit fundamentals will soften in the coming quarters as the economic slowdown leads to weak income growth and profit margin pressures pose challenges to profit growth. Against this backdrop, spreads slightly below the average levels of the past 20 years appear unattractive. Another issue to watch out for is the overall declining investment quality of USD, GBP, and EUR corporate credit. While a selective approach is compelling, the institution believes investors can wait for better entry points at the current spread levels. Similar to investment-grade bonds, high-yield bonds have been trading at relatively narrow spreads. Current default rates are not high, but as the institution predicts an economic slowdown in 2024, default rates are expected to rise. In this environment, the distress ratio and average index spread are expected to increase. Therefore, the institution believes that high-yield bonds are not attractive considering the current spread levels. Emerging market debt in focus In a backdrop of increased volatility and uncertainty, hard currency emerging market sovereign bonds appear attractive in terms of the provided spread. As the spread of high-yield segmented markets is well above long-term average levels, market prices have already factored in most credit events. With changes in index credit ratings, credit quality has also changed. In the high-yield space, as a result of national defaults, debt restructurings, and rating downgrades, the proportion of the lowest-rated credits has increased. In contrast, within investment-grade, the proportion of the highest-rated credits has increased primarily due to the entry of higher-rated Gulf countries, which have historically been large issuers of bonds, improving credit quality. Additionally, if the US does not experience an economic recession, spreads could further narrow. When data turns, market prices begin to factor in a dovish shift in Federal Reserve policy, and a rebound in US Treasuries could bring additional upside potential. On the other hand, the situation for local currency emerging market debt (EMD LC) is much more complex. Firstly, emerging market currency policies are no longer following the Federal Reserve, resulting in the spread between EMD LC and US Treasuries reaching its lowest levels in 15 years. Secondly, the strengthening US dollar casts a shadow over the near-term outlook, not only due to its direct impact on returns of emerging market currencies but also indirectly due to its impact on emerging market inflation. However, for some of the largest components of the broader EMD LC index, real yields have turned positive, although still lower than US Treasuries, but have rebounded compared to the eurozone.