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Optimism for Risk Assets, Caution on Duration 


2014 US Fixed-Income Outlook 


CIO Fixed Income US Doug Forsyth says Fed tapering is one of several positive signals for the economy that should give companies confidence. Investors should be optimistic about risk assets in 2014 but cautious about longer-duration bonds.
The US economy headed into 2014 showing clear signs of strength, as key areas that had been in question throughout 2013 were resolved during the fourth quarter:

Corporate earnings continued to surprise on the upside
Economic statistics consistently beat expectations
Progress was made on D.C.’s debt ceiling and budget battles
The Fed¹ announced that QE² tapering would begin in January

We have long argued that the Fed’s asset purchases have been acting as an artificial sweetener, preventing companies from developing certainty about their expectations for growth and capital expenditures. By maintaining its high levels of QE, the Fed was sending the markets a pessimistic signal—but tapering helps companies gain more confidence. The Fed will remain highly accommodative for some time, but eventually there will need to be a “handoff” from fiscal policy to fundamentals as being the primary driver of markets. In our view, the sooner the better.

With the economic recovery on solid footing as we enter the new year, we are optimistic about risk assets but cautious about longer-duration fixed income, as long-term interest rates should begin to drift higher.

The outlook for credit is positive, with minimal defaults projected for 2014 and 2015. For below-investment-grade high-yield bonds, a coupon-like return is possible over the next 12 months. Investment-grade corporates will be more negatively impacted by higher interest rates given their much higher correlation to Treasury bonds. While further rate moves will have an impact on the high-yield market, the trading trajectory should be more disciplined and structurally consistent with expectations for yield, spread and rating categories. High-yield bond spreads are approximately 430 basis points over comparable Treasuries.

This stage of the market cycle, from a statistical perspective, is best compared to the mid-1990s and mid-2000s—market environments that exhibited economic stability, low defaults and ample liquidity. The high-yield market has priced in a default-rate forecast that is higher than the current rate. The yield generated by high-yield issues relative to the risk associated with the asset class is clearly attractive. Caution is warranted for the narrower-spread issuers, primarily in the BB category, as they will have higher correlations to interest rates.

¹ Gross domestic product
² Quantitative easing

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.


High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. U.S. Government bonds and Treasury bills are guaranteed by the U.S. Government and, if held to maturity, offer a fixed rate of return and fixed principal value.


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