BlackRock’s Suggested 2023 Buys: Investment Grade Corporates and Just 2 Other Bond Types

Expect a recession next year, and also inflation that’s not quite tamed (higher than the 2% Federal Reserve target), says BlackRock. Fixed income is a typical refuge for investors in an economic downturn, but the world’s largest asset manager expects problems with a lot of bonds, given the inflation situation—long-term Treasuries, for instance, will see higher yields and thus lower prices amid still-pesky inflation.

So what does that leave? In BlackRock’s view, not equities, whose earnings will suffer in the coming recession. A lot of bonds are best skipped, such as British government paper, aka gilts, due to the U.K.’s tattered credibility amid the government’s recent screw-ups, the firm says.

Three types of bonds stand out as overweights, BlackRock finds, in its 2023 global outlook: global investment grade bonds, U.S. agency mortgage-backed securities and inflation-protected bonds. The current environment “calls for taking more granular views by focusing on sectors, regions and sub-asset classes, rather than on broad exposures,” the study declared.

“The macro damage we expect for next year is yet to be fully reflected in market pricing,” said Wei Li, global chief investment strategist at the BlackRock Investment Institute, its in-house think tank.

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BlackRock does not expect the Federal Reserve to at some point reverse its tightening campaign, as many investors hope. Not gonna happen, the study predicts. “Policy rates may stay higher for longer than the market is expecting,” the firm’s report said. “As a result, we remain underweight long-term government bonds in tactical and strategic portfolios.”

But IG credit looks good to BlackRock. One big reason is that companies have stockpiled a lot of cash and are not over-leveraged. IG debt “can hold up in a recession, with companies having fortified their balance sheets by refinancing debt at lower yields,” the report stated.

Things also look solid for agency-backed MBS, and in the U.S., that chiefly means Fannie Mae and Freddie Mac bonds. As the 2008-09 financial crisis showed, Washington is there to rescue them if the worst occurs. These days, of course, the agency securities are on much firmer ground, with better underwriting standards providing a strong base of mortgages. Plus, the report noted, “soaring U.S. mortgage rates have boosted potential income.” No kidding: 30-year fixed home loan rates now average 6.6%, twice its level from 12 months ago.

While BlackRock did not give an inflation forecast, it insisted that price levels will remain elevated compared with the pre-pandemic situation, when inflation was routinely around 1%. That underscores the need for inflation-linked securities, it contended.