Attractive Income Opportunities for Uncertain Markets

In a turnaround from last year, there is renewed interest in the fixed income asset class as yields have risen. Ed Perks, CIO of Franklin Income Investors, shares his analysis of recent macro developments and where he sees opportunities for income.

Key takeaways:

  • Interest-rate hikes in the United States are on pause but may remain higher for longer with lagged effects likely to manifest in early 2024.
  • There is renewed investor interest in fixed income as the asset class offers the potential for income and total return.
  • Equities have remained resilient but restrictive monetary policy may impact corporate revenues going forward.
  • Our asset mix favors fixed income and within this asset class we prefer investment-grade corporates. Within equities, we prefer high-quality dividend stocks.

A pause in US rate hikes

Looking back, the US Federal Reserve (Fed) was behind the curve in starting to tackle inflation. However, once it did, it raised rates quite substantially from 0.25% in March 2022 to 5.50% in July 2023. Despite the significant rise in rates over the past year, we believe there are valid reasons for the current pause in hikes.

In March 2023, there was some concern that hearkened back to the global financial crisis as higher rates caused banking stresses, hitting US regional banks particularly hard. Concerns of contagion to the rest of the industry and the economy more broadly turned out to be unwarranted. The crisis was more idiosyncratic and affected regional banks with poor risk controls. At the time, the Fed expanded their balance sheet, while it tried to understand the ramifications of the few regional banks that collapsed.

With the US Treasury also injecting liquidity into the markets, the effect of the tightening was delayed. By summer, the Fed moved back into quantitative tightening in a meaningful way and into more restrictive territory.

Although inflation remains high, monetary policy tends to have a lagged and variable effect. In our view, we could start seeing the lagged effect of the Fed’s tightening efforts in a more material way in the first quarter of 2024.