In a world of slow yet steady, non-inflationary economic growth, interest rates are likely to remain at relatively low levels over the medium term.
With secular stagnation forces at play, we expect monetary policy prudence to prevail, but in the absence of further economic deterioration, any additional easing will now be minimal, removing a performance driver for government bonds.
Stable macroeconomic outlook and a prudent, if not accommodative, US Federal Reserve and European Central Bank should provide support to credit markets.
However, historically tight spreads make credit markets more vulnerable to emerging macroeconomic threats or to a rise in risk aversion.
We are keeping a close eye on default rates that could creep up from excessively low levels.
In this regard, in the absence of the benefit of tax cuts and lower rates, corporate profitability is now more dependent on top line revenue and economic growth. ESG considerations, notably relating to climate change, are also growing and must be integral to investors' assessments.
We currently see opportunities in emerging market debt, which offers good diversification with economic growth slightly de-correlated to the US.
We acknowledge future returns will depend significantly more on country selection than a year ago.
Particular idiosyncratic risks apply in Argentina, South Africa and Turkey, while Brazil, Mexico and, to a lesser extent, Russia seem to be more stable and have our preference.
Local currencies have room for medium-term appreciation, while valuation levels look as stretched in emerging market hard currency as in credit markets.
In the context of muted economic growth, shocks can come from various sources.
As such, we expect further spikes of volatility this year, with investors moving between risk-on and risk-off scenarios as developments occur.
Considering this environment and high valuations across some fixed income segments after last year's rally, we think investors should be selective.
An emphasis on fundamentals will be important.
Xavier Baraton is global CIO for fixed income, private debt and alternatives at HSBC Global Asset Management
• Low inflation will keep central banks on a prudent stance offering liquidity support
• With stable macro fundamentals, any increase in risk perception and yields should offer buying opportunities
• Valuation levels across spread markets were tight at the start of the year recommending caution on betas
• Particular attention should be paid to country, credit selection and ESG factors to differentiate