Nomura Bullish on Fixed Income, Cautious in Near Term

Nomura is bullish on the fixed income market over the medium term, citing compelling yields and expectations of interest rate cuts by the Federal Reserve later this year.

"Rates are ultimately in deeply restrictive territory and will need to be cut repeatedly to avoid undue pressure on economies that have been propped-up by government spending," said Richard Hodges, Manager of the $2.2bn Nomura Global Dynamic Bond Fund, in a memo published last week.

Hodges noted that markets have moved away from pricing in multiple Fed rate cuts starting as early as March, which Nomura believes was overly optimistic. However, he continues to believe that the Fed will cut rates later in 2024, with the first cut delivered around the middle of the year.

"We suspect they may cut as many as 3 times, in line with what they have communicated so far," Hodges said.

The primary risk to this scenario, according to Nomura, is that inflation and wage growth remain stubborn, leading to fewer rate cuts. As a result, Nomura is cautious about adding duration in the near term and is also wary of credit spreads at relatively tight levels.

"We remain extremely positive on fixed income markets looking further out in time," Hodges added. "Yields are high, allowing investors to earn attractive carry for moderate risk, and the prospect of capital returns in addition to that carry is significant."

In keeping with this view, Nomura currently has substantial exposure to some risk areas of fixed income markets, including senior European bank debt, contingent convertible / AT1 bonds, convertible bonds, and emerging markets. The firm is also using CDS index positions to hedge against risk.

Overall, Nomura believes that fixed income investors can earn attractive returns over the medium term. However, the firm advises caution in the near term, given the risks of stubborn inflation and fewer rate cuts than the market expects