2024 Public Fixed Income Outlook

Greg Campion: 2023 gave investors no shortage of challenges to face in their fixed income portfolios from rapidly increasing interest rates to inflation to geopolitical conflict. But what lies ahead for 2024? Will investment grade credit be back in vogue? Can high yield markets avoid a wave of defaults and are emerging markets even investible? Welcome to the Barings 2024 public fixed income outlook where our experts across credit markets ranging from investment grade and securitized to high yield and emerging markets, will weigh in on the biggest risks and opportunities in the year ahead. This is part of our 2024 Outlook series. In the coming weeks, you'll hear from us not only on fixed income, but also on global real estate and direct lending as well. You can follow along on our streaming income podcast, feed, our YouTube channel, or by visiting barings. com, where we'll be posting audio, video, and written versions of these conversations. With that here is Barings' Matt Levis to kick off the discussion.

Matt Livas: Hello and Warren, welcome to everyone dialing in. We're very pleased to be hosting so many of you from all over the world for what I know will be an exciting discussion. My name's Matt Levis. I'm heading the public fixed income client portfolio management team here at Barings, and I'll be your host for the duration of this round table discussion. Today we're diving into the outlook for fixed income markets as we head into 2024, and we themed our outlook this year as coming into focus. Certainly there's a lot of uncertainty in the world right now that has the potential to weigh in on the investment landscape going forward, even though and as I believe our panelists will tell you, we do see attractive opportunities in many markets. And that's particularly the case here at Barings, where we spend a lot of time looking at the world from the bottom up, issuer by issuer, deal by deal, and credit by credit. And we think that's the best way to uncover the best risk reward opportunities even, and maybe even especially, in a world where the macroeconomic picture looks increasingly unclear. So hopefully we can get into some of that today as well. But let's start first today with some introductions. Can I please ask each of our panelists to introduce themselves, state their role here at Barings and also maybe a book or a podcast recommendation they may have for our audience? So Ricardo, let's start with you.

Ricardo Adrogue: Thanks, Matt. I'm Ricardo Adrogué, the head of global sovereign debt and currencies at Barings. The book that I read this year that I highly recommend that I enjoyed the most is Titan: The Life of John D. Rockefeller by Ron Chernow. A very complex character, a very interesting time, the all gilded age.

Matt Livas: Thanks Ricardo. Yulia, what about you?

Yulia Alekseeva: I'm Yulia Alekseeva, head of securitized credit research and a portfolio manager here at Barings. And I'll go with the most recent book just because I can remember it most vividly. It's called Hidden Potential. It's a book by Adam Grant, who is a professor at my alma mater, and he just published it in October, so it's fresh from the print. And it's really a book that focuses on how we can improve in improving, and I enjoyed it as a parent thinking how I can develop potential for my two little boys. But I think it's also a great read for any business leader who is tasked with developing talent more broadly.

Matt Livas: I think we could all use some self- improvement. That sounds like an interesting recommendation. Brian, can you please introduce yourself?

Brian Pacheco: Yeah, hi, I'm Brian Pacheco, portfolio manager on our global high yield team. It's interesting to hear Yulia mention Hidden Potential because I have a similar rec, but it's via podcast. So Dr. Gio Valiante on Peak Performance, an interview on the Meb Faber show from the summer. Dr. Valiante is a famous" mental game coach," so he works with the Buffalo Bills, started out in golf. He's worked with Tiger Woods and other famous golfers and was recruited to work with hedge fund traders by Steve Cohen a few years ago. So I really sort of enjoy the parallels between sports and investing psychology. So this podcast is loaded with great anecdotes and a fun listen for anyone interested in the psychology of winning or losing for that matter.

Matt Livas: That's great. So we've got two book recommendations there, one podcast recommendation, and I think something for everyone hopefully. But let's move on to talking a little bit about the macro environment and maybe surprises around this year. There's a lot of uncertainty in the world today. Questions out there. Are we headed into a recession? If so, how long or how severe will it be? What will interest rates do going forward? Geopolitical tensions are obviously increasing, what does that mean for the market and opportunities out there? So against that backdrop, I just want to ask a couple of questions and Ricardo, starting with you, probably the biggest macro surprise this year has really been how far rates have continued to move after the big move in 2022 and consensus seems to be for a higher for longer rate environment going forward. Has that surprised you and how do you see that playing out in the year ahead?

Ricardo Adrogue: Yeah, it has been a big surprise and the surprise has been not just that rates have moved higher, but that the US economy has accelerated through the rates hiking cycle and not just the Fed hiking cycle, but the overall yield curve moving higher. And it wasn't just those rates that moved up. The 10 year moved up, the mortgage rates moved up, the dollar strengthened, the rest of the world actually went very close to recession so it was pulling US growth down. So that has been the biggest surprise, the near term growth. And then when we look for causes, well, we have the balance sheet of companies and individuals and households that was very strong. That explains potentially the resilience, but not necessarily acceleration. But two other elements may explain some of the near term expansion. That was the fiscal policy in the US that it expanded quite radically despite the fact that the country and the government almost closed down back in June. And then some acts on legislation that was passed in late 2021 and 2022, including the Infrastructure Bill, the Chiefs Act, and the IRA, the Inflation Reduction Act, all of which seem to have promoted investment, private investment, which may be ongoing. Now that past history, that explains sort of why the US economy may have expanded even though the Fed was trying to cool it off. Now, what is more significant is that the inflation adjusted interest rates in the US moved up by three hundred basis points in that same time period in, 18 months, from negative 0.5% to 2. 5%. That is a massive move. And that may suggest that the global economy, and in particular the US economy, may be headed for a longer period of strong growth. So higher for longer doesn't necessarily mean the Fed staying higher for longer, higher for longer may mean that real rates the potential growth of the US economy may have moved up. Now what is the evidence that an economy can change so much in only 18 months? That is remarkable. That's strange. So the one book that we found potentially instructive on this is by Mordecai Kurz, a Stanford professor, that basically says that we have been through the new Gilded Age. I talked about the old gilded age under Titan, the new gilded age, that once that comes to an end, then we may be perceiving decades of very strong and positive growth in developed markets and particular the US.

Matt Livas: So just moving on, Brian, and turning over to you. I think another big surprise this year has been that strong performance across high yield bond and loan markets. Both are effectively the best performing asset classes or one of the best performing asset classes within fixed income year to date. Now some of that is obviously due to their lower duration or interest rate sensitivity in the face of those higher rates, but that's not the full story, is it? So can you just give some insights on what are the other main catalysts that have been driving that performance and can that trend continue going forward?

Brian Pacheco: Right. Well, duration's a big piece of it, as you mentioned, I think more than positive catalysts, it's just a lack of negative catalysts. So we did have a scare with regional banks in the US, but that was short- lived and really investors were very bearishly positioned coming into this year expecting a very tough environment. So that means up in quality, long rate, duration, short spreads, and really that was the wrong way to be positioned because as Ricardo mentioned, economic growth accelerated as opposed to decelerating. So within loans, investors were expecting default rates to spike, SOFR to roll over, a potential downgrade wave with forced CLO selling. And we just didn't really see that. Partway defaults have been around three, 3. 5% including distressed exchanges. SOFR increased, higher for longer. So that was a tailwind to loan or floating rate returns. And then downgrades have been very manageable. So triple C buckets that were over seven and a half percent in Covid was about 87% of the market, that's only 30% or so today. Within high- yield bonds I think investors were less bearish coming into the year than loans, but still pretty defensive up in quality, which tends to mean longer duration. Of course, that was the wrong trade as rates went higher instead of lower. And I think a lot of investors were largely avoiding triple Cs and triple Cs, they're the most sensitive to economic activity and triple C spreads have tightened by 116 basis points versus 31 basis points for the market overall and has been the best performing subsegment of high yield. So to summarize, historically attractive starting valuations and then just a lack of negative catalysts.

Matt Livas: And how do you see that playing out? Is that going to continue?

Brian Pacheco: Yeah, so forecasts are always tough. I'll quote some stats which is going to be US focused, but Europe has been similar if not even better. So loans have returned 10% year to date, yet the current yield, so price over coupon of loans is around 9.5%. So even though you've had this strong year to date performance looking forward, unless you have some sort of massive macroeconomic shock, there's a large embedded cushion in your current yield. Same thing with high yield. High yields up 5% through October off to a hot start here in November, up another 2%, but your current yields within high yield are at 7% and potentially you'll get a tailwind from rates if you have any sort of slowing in economic activity. So we're all sort of waiting for the long and variable lag to start to have a much more meaningful impact on economic activity. We're seeing some signs of that, but current yields we think are really compensating you. And historically, when you've said it's a coupon clipping market, that's always been kind of perceived as a negative, but these days with income as high as it is, a coupon clipping market is actually a very solid return.

Matt Livas: So just moving on to a little bit more detail and fundamentals and really as we aim to look to provide some clarity and focus around the uncertainty in the broader market, I just want to dive into what each of you're seeing in terms of fundamentals. And Yulia, let's start with you because arguably one of the surprises this year has really been how strong the US consumer continues to be, and there are a lot of headwinds on the horizon with respect to the US consumer. And so I just want to get your sense of do you think this strength can continue? What are the repercussions for the higher quality parts of the fixed income market?

Yulia Alekseeva: Yeah, Matt, I mean we all know the macro indicators. We know that the unemployment is low, the wages are strong. And so overall it does seem that the consumer has been resilient. What I would say is that we see a lot of cracks forming, and specifically in the subprime part of the market, which tends to correspond more to the bottom income quartile of the US borrowers. And so I think a unique perspective that we have that the securitized markets offer us is the glimpse into the health of US consumer by analyzing a lot of high frequency data that we get, such as auto loans, student loans, personal loans and mortgages through the monthly remittances that we get. And so what we're seeing is that subprime consumer has essentially depleted their fiscal stimulus savings and we're seeing stress. We are seeing auto loans spike over the last year. We're seeing the same trend in consumer loans as well. And so then looking forward, if you think about student loans, the payments have resumed last month. So after a few years, of course, now we're introducing a new part of the equation and the impact is likely going to be felt again by consumers with lower incomes in a more disproportionate fashion. If you think about credit card balances, we see them rising. In fact, the total amount of credit card debt over the last reading has exceeded a trillion dollars for the first time in the history of this metric. Everything's more expensive, it's more expensive to borrow, the valuations are higher, so it's not surprising. And then the last thing I'll say where we have sort of more fresh perspective is on the housing side. Housing has been very resilient, but our analysts have just completed their October review of non- qualifying mortgages and what they're flagging to us is that delinquencies have increased significantly month over month. And it's also driven by subprime borrowers. And this is the largest non covid monthly increase in delinquencies inaudible in the sector's history. And so this could be an early warning sign that could indicate that the borrowers are overextended, they're starting to miss the payments and so if we do stay higher for longer, it'll not help the US consumer, which drives two thirds of the US economy. All of this data points are suggesting that US consumer is more skewed to the downside. And so we do expect continued fundamental deterioration in'24.

Matt Livas: And what about corporate fundamentals? What's your outlook there?

Yulia Alekseeva: Corporate fundamentals are normalizing, but they're still fairly strong. And so when we look at Q3 earnings and sort of reflect on what we've learned, most corporates have generally met expectations. The outlooks going forward are softer. And so if you think about leverage, it increased, but it's still sound. Higher rates will be a headwind for interest coverage going forward, but that hand width will be gradual. It won't happen overnight. And so if you reflect on the post covid years, I do think that corporates managed their balance sheet very conservatively, right? They termed out a lot of debt logging in historically low financing costs and so now they're pretty well positioned with a lot of financial flexibility. They have excess cash on hand, they have access to public financial markets. They have ability to conserve liquidity by limiting actions such as buybacks, so not really concerned. And so other than stress and regional banks and office reads, most sectors are actually very well positioned fundamentally, if we are to head into a recession, which is very different from 2015 and'16 when we had the commodity crisis and a lot of those sectors had really weak credit metrics and negative cash flows. And then last thing I'll say is that we had pretty muted M& A activity over the last three or four years. And so basically we have less leverage in the system right now. And so this time is also very different than 2018 when there was a massive concern over a number of triple B issuers that got over levered and could fall to high yield. In fact, this dynamic is almost reversed right now.

Matt Livas: Yeah, absolutely. I think actually an interesting stat I saw recently was that upgrades are outnumbering downgrades within the investment grade corporate market at a rate of four to one this year. So I think that just sort of goes to show towards the resilience of the corporate issuers out there. Why don't we move on to high yield and loans? And Brian, when you look at those asset classes, what are your views on default rates for 2024? Do you expect to see a big wave of defaults going forward, in fact, as some sell side analysts are predicting? Or are those forecasts too negative in your view?

Brian Pacheco: You're right. Some sell side analysts are predicting some Draconian default rates, and we'll get into that. I guess first I'll talk about our base case is that the economy slows for some reasons Yulia mentioned and defaults pick up. We don't see a big wave per se, maybe three to 4% type default rate. That's a par weighted including distressed exchanges. So that's a bit higher than normal ranges. But I do want to make a few points regarding default concerns. The first one is that markets are forward- looking. So if a recession or a sharp slowdown happens, it'll be one of the most forecast or anticipated in history. So most credits that are going to default in the next 12 to 18 months are not trading anywhere near par. So there's a lot in the price. Two, high current yields can absorb expected defaults. So to use simple math, if you have a 5% default rate, for example, which is higher than we're projecting, but you lose half your money on those defaults, that's only a two and a 5% loss rate against those high current yields I cited before, 7% in high yield in 9.5% in bonds. So it's really hard to get to a negative return over the next 12 months without some really Draconian default assumptions. So I guess touching on the Draconian assumptions, so some may ask, well, why can't we have a nine to 10% default rate? And the answer is because the math just doesn't work. The quality of the high yield market is very different than it was a decade ago. So double Bs, for example, are just under 50% of the market that was 40% 10 years ago, triple Cs, which is where you usually see most defaults are only 11 and a half percent of the market versus over 20% coming out of the financial crisis. So if you just apply historical default rates, double Bs within 12 months, typically don't default, it's like 0. 5%. Single Bs do default. It's low 2% on average, even covid, which is sort of the definition of an exogenous shock, default rates for single Bs, were still less than 5%. So you sort of apply that 0. 5% to double Bs, 2% for single Bs, and you would have to have literally two thirds of the triple C market default in the next 12 months to get to a 9% default rate. So the math just doesn't work outside of some sort of massive macroeconomic shock like covid or the global financial crisis. So we're sort of much more sanguine. So yes, to summarize, defaults are probably going a bit higher. The high yield market is healthy overall. There's a lot of carry and investors have been expecting defaults to pick up for a long time. So there's a lot that's priced in.

Matt Livas: I think it is also interesting how in contrast to some of the other default cycles in the high yield market, you're not seeing a lot of stress in any one particular sector. So when you're looking at distress in high yield, it's spread out among a number of sectors. Is that right?

Brian Pacheco: Yeah, that's a great point. So in 2015, you had a massive drawdown because oil prices collapsed and energy was a huge portion of the high yield index. Energy is still a large portion of the index today, but the quality mix is very different than it was. A lot of the weaker players have really either restructured and gone out of the industry or there's been M& A, they've gotten bigger, there's been fallen angels that have come from investment grade into the high yield market. So it's just a very different mix than it has been historically. So that's a good point, Matt.

Matt Livas: Just moving on to emerging markets. Ricardo, when you look at EM, of course it's really not a homogenous asset class, a lot of differences across issuers, but are there any themes or trends you would highlight with respect to fundamentals, maybe by region or perhaps a distinction between emerging markets and frontier markets?

Ricardo Adrogue: Sure. So emerging markets, the way we are looking at it and we are perceiving the stage in which we are is very similar to the 1990s, mid 1990s and late 1990s when the US economy was chugging along, was growing really fast. Financial conditions in the US were tight and emerging markets were facing lots of difficulties finding financing. And so the lenses by which we prefer to look at each one of the different emerging markets that we focus on is precisely by that, which ones are the ones that have domestic financing that can survive because they are self- financing effectively? As opposed to those that are more in need of foreign financing that have not really domestic markets and a lot of times have fixed exchange rates and therefore they're in deep trouble. So the natural conclusion from that is that we are probably in the early stages of more waves of default in emerging markets on the hard currency side, some of them could be considered more frontier markets. At the same token, much like what Brian was saying, a lot of that is already in the price. And so we are seeing a lot of countries that are pricing at distress levels, distress as in prices below 40. We have not seen in very, very long time, I guess from the time I remember in 1990s when the market initially started, so many countries that are at those levels, at these stress levels. Now the sum of all those countries are only a small fraction of the index. So when people think about, well, emerging markets therefore is not a good asset class because they're going to have a lot of defaults, some of which is already priced in, but the sum of all of them is about 10% of the index. So 90% of the index is relatively healthy, 10% of the index is in distress, and that 10% is pricing a large probability of the fall, which we think will materialize. The one thing that we do find is that in the past three years, the international community and especially the multilaterals that are basically the lenders of last resort for emerging markets, they have done sort of a flip. Back post covid, the International Monetary Fund, the World Bank, were pushing really hard for countries to restructure their debts to declare default, to tell investors we cannot pay. And some of the pricing that we have seen in the bonds is because investors came to the realization that a lot of these countries were going to try to propose very harsh restructuring terms. And unlike my colleagues from the corporate side, there's no supernational court that decides how much each investor should get on the sovereign side. Sovereigns pay effectively, whatever they want. Now, the most recent events that have taken place, the most recent restructuring announcements by Zambia and by Surinam, they seem to suggest that the terms of the restrictions are not that harsh for investors. And the rhetoric coming out from the multilaterals seem to have shifted from what was right post covid to now we perceive that they're saying we prefer to try to find solutions other than default in those countries. So that means that some of those very distressed levels that we're seeing are great opportunities. So a inaudible structure could be a great opportunity for investing in emerging markets.

Matt Livas: I mean certainly overall, just listening to what the three of you have talked about, it feels like there are pockets of weakness in your respective markets, but overall no broad- based concerns. So with that, if we move forward to thinking about opportunities going ahead, and Ricardo, I just want to stick with you. Really for the first time in 15 years, you're now getting attractive yields across fixed income, certainly even across the higher quality parts of the fixed income market. And I just wanted to get your sense, what are the implications of that in terms of where are you seeing opportunities right now?

Ricardo Adrogue: So it is true finally, after more than 10 years of very, very low yields, yields in developed markets are reasonable. They're high enough to potentially be attractive. I mentioned early on today that potentially high rates are here to stay, not just because the Fed will be there for longer as they like to say, but more important because there may be some structural elements that cause real rates to be high. So investors could potentially start going into developed market interest rates because they already offer an opportunity. You also heard from Julia that potentially the strongest component of the US economy, which has been the consumer, we're starting to see cracks. And from there, therefore we can suggest potentially this is the best time to be investing in developed market rates because we may not see these high levels of rates for much longer. So either way, either because rates in developed markets remain high or because they go back to where they were three or four years ago, this is a great time to be investing in developed market rates. By the same token I mentioned that emerging markets do offer some attractive opportunities. One is the distress that I mentioned earlier, some distressed names that are offering prices of 20, 30 that we think should be worth maybe 60 cents. So you can double or more than double your money in some if you pick those right. And the third one is emerging market rates are in a different cycle than developed market rates. A lot of emerging market countries have not done the policies that developed market rates have done, they have not gone into quantitative easing and they're not in quantitative timing. Now they have not done big, big fiscal expansions are continuing to do so. And so a lot of interest rates in emerging markets are, local interest rates, are extremely attractive. So those countries that have the ability to borrow from their own domestic markets and that have broad inflation under control, which is most of them, offer great opportunities in emerging market local rates.

Matt Livas: And Brian, there's a similar theme in high yield today. If you look at double B, high yield bonds for example, they're currently yielding seven to 8%. How's that shaping your approach to high yield bonds and loans and really are there areas there that look particularly attractive to you?

Brian Pacheco: Yeah, so double Bs at seven, 8%, it's pretty extraordinary when you compare that to the S&P 500, which has returned around 10 or 11% over the last 50, 100 years. So there's yield everywhere. You don't need to stretch for risk. At the same time, we're active managers. Our clients pay us to outperform benchmarks and we generate alpha through credit selection. So within that vein, we're very bottoms up. It is situational, but thematically we're seeing opportunities in high spread yield to takeout trades, so fairly close maturities where the borrower has liquidity levers or secured capacity, essentially multiple ways to refinance, which we think is the risk is being overpriced. Double Bs or high quality single Bs, as you mentioned, you're earning a good carry there, but we look for a catalyst for spread tightening, so that could be earnings momentum, an IG upgrade potential, et cetera. I think probably less opportunity here in triple Cs. We'll always own some given our bottoms up process, but it's not as obvious of a trade as it was at the start of the year given such a big run- up year to date. Within loans, there's a lot of carry in the loan market. I mentioned current yields north of 9%. You can buy double Bs and clip seven and a half to 8% while taking very little credit risk. But there's also opportunities in lower rated segments of the loan market. You're finding first lien loans that offer equity like returns, which is pretty rare outside of major macro events like the financial crisis and covid.

Matt Livas: And Yulia, for an investor looking at investment grade credit and US securitized markets, where do you see the best value right now?

Yulia Alekseeva: Yeah, so we generally like securitized, but there is a sector that probably deserves a special mention and that's a sector that I haven't really recommended in my career, which is agency mortgages. And so the sector has become attractive for the first time in a decade and there's a lot of reasons behind it. Obviously rate volatility didn't help. We had horrendous technicals over the last couple of years, but where we are today is mortgage valuations are attractive. They're attractive on an absolute basis where essentially nominal spreads and option adjusted spreads which account for prepayment risk are both in 99th percentile versus 10 year history. They're also attractive versus corporates on a relative basis. And so if you think about mortgages, there is no credit risk given the government guarantee. It's essentially a convexity risk. But what has happened over the last couple of years is a lot of the pockets of the market have been extended to the maximum. And so that prepayment risk today is actually pretty low. Less than 1% of the current mortgage universe is refinanceable. So we think of it as a coil spring that has been extended to the max, which has a lot of upside potential should we hit some sort of a software recession where Fed has to cut the rates, a lot of that convexity will be actually favorable given where we are. And so bottom line is we think that this is a very attractive entry point for mortgages for those who have been sitting on the sidelines and it does present a generational opportunity to lock in some bonds that are trading at 70, 80 cents on the dollar. And so if you think about it for the future, it does imply a more attractive return per unit of risk going forward. And so we think of mortgages as potentially a recession hedge trade as well given the liquidity and the government guarantee mortgages should actually fare better relative to the rest of the fixed income universe should there be some sort of more pronounced recession. And beyond mortgages, there's plenty of attractive spots within securitized, like higher quality, shorter assets where you benefit from the inversion on the front end, you clip roughly 7% coupon while being pretty well insulated from credit risk because you're so higher up the capital stack. And also you invest in a lot of naturally de- leveraging assets, so you de- risk your basis as you potentially get closer to recession. A lot of those sectors have lower correlation versus the broader fixed income so it's not a bad place from our perspective to wait it out until we have a little bit more certainty on what the future holds.

Matt Livas: That's great. Thanks all three of you and I think it's been some really interesting commentary there. But just to zoom out a little bit, and also in the context of everything you've told us, can we just pretend for a minute, you're an institutional investor responsible for managing a fixed income allocation, you have a multi- year horizon. What's the one move you would make today to try to set yourself up for the long term? And maybe Brian, I'll start with you on this one.

Brian Pacheco: All right, well one move is tough. I guess first and foremost, you need to be invested, plain and simple. There's too much income to sit on the sidelines and try and time it perfectly and every month you're not in the market, you're losing that income. But I think if there's one thing, it's probably beware of reinvestment risks. So it sounds nice to buy double B loans or" T- Bill and chill," but you need to own some duration here, especially if you've been smart enough to be underweight duration after such a huge rate move. I guess finally maintain a strategic allocation that goes hand in hand with staying invested. Buying opportunities don't typically last very long and you need to be in the market to sort of recognize and take advantage of those dislocations when they do come.

Matt Livas: Yeah, certainly the time invested maybe matters more than time of investment. I think it's perhaps one key lesson there. Yulia, can you answer the same question? What would you do?

Yulia Alekseeva: Yeah, so I might be a little bit biased, but I do think'24 will be a good year for investment grade credit and the reason for that is multiple. First of all, if you think about the current rate environment, you really have very high yields from a historical perspective. So even though let's say IG corporates are pretty tied from a spread perspective, from a yield perspective, they're at the highest level since 2009. So it's a unique opportunity to lock it in for future. Similarly, a lot of securitized spreads are very high spread percentiles, so we're talking about mid to high single digit yields. And so I think given all the uncertainty that we've been talking about, it's prudent to go to higher ground and emphasize higher quality bonds across sectors and geographies until there is more clarity. And so I think really the storyline of'24 will be selectivity. And so if capital allocators are making the decision right now what to invest in, I think it's more important to focus on the right managers who have deep fundamental bottom up capabilities who will take advantage of the dispersion that we've talked about on this call. And I think that performance dispersion will continue growing because higher cost of capital will inevitably deepen it across all asset classes, public and private. And so I think really'24 will be the year of bond picking similar to what we had with stock picking. I think finally we're in an era where not everything is great and not everything will be rosy and so I think that will create opportunities for bond pickers going forward.

Matt Livas: Ricardo?

Ricardo Adrogue: My recommendation would be much in line, diversify if you don't have into developed market rates, they offer a great hedge to the current market environment, which is of great uncertainty and if you have extra amount of risk that you can devote, pick a good manager to do inaudible.

Matt Livas: Okay, so before we finish off with some Q&A, I just want to move on to our lightning round and I'm going to be posing each of you a few quick questions in rapid fire format. So for each of these maybe Ricardo if you answer first, Yulia, you go second and Brian you go third. So start with the first one here. US recession in 2024, yes or no?

Ricardo Adrogue: No, I think the most likely scenario is a soft landing.

Yulia Alekseeva: I take the other side of that. I'd say yes just because I'm starting to see meaningful deterioration in credit that is not obvious that a macro level but that can transpire very quickly.

Brian Pacheco: I'm going to say no. I think if you predict it for too long, behavior actually changes and you don't get the requisite excess.

Matt Livas: Okay, no's have there. Next question, 2024 US election, Trump, Biden or other?

Ricardo Adrogue: I believe Biden because if it is a soft landing that's a pretty important condition for him to be reelected.

Yulia Alekseeva: I'd probably go with other. Age is a factor for the existing contenders, but also I think right now people are in this choosing lesser of two evils paradigm and what we've seen in the past, is candidates can emerge very rapidly before election, that was the case with Obama and so we might get a surprise and might be a good surprise, hopefully.

Brian Pacheco: I'll say other as well. I'm an optimist and we'll leave it at that.

Matt Livas: Interesting. That's great. So next question, US 10- year yields higher or lower than 5% by the end of 2024?

Ricardo Adrogue: At 5% given that the economy will be doing okay.

Yulia Alekseeva: I would say marginally lower, but I don't think it's going to be meaningfully lower than five but lower overall.

Brian Pacheco: I'll stick to lower. I'm not going to say how much lower, but I do think things are slowing. So the direction of travel is down.

Matt Livas: We've reached the turning point. Okay. What about next question here, best performing asset class in 2024, what are your predictions?

Ricardo Adrogue: There's a very difficult one. I think potentially emerging market debt has a great potential to be in a very good asset class. It has under, well I don't know if it has underperformed other asset class, but it has done quite poorly since covid and there's some structural features that suggest that maybe it will be turned around.

Yulia Alekseeva: I would say bonds over equities and within bonds I have a little bit of a home bias for securitized. A, because it's been lagging corporates while the fundamentals have been strong. B, because we've seen a number of really bitten down sectors like CMBS that have just really fallen off the cliff. And so we see fundamentals sometimes decoupling from technicals and so they could bounce back very similar to the story that Ricardo mentioned for distress we've been seeing in emerging markets. So I think that bounce back might surprise us, but I think a safe answer would be something like agency mortgages, which we have talked about already for the reasons that I mentioned.

Brian Pacheco: So I'll go with double B CLOs. Double B CLOs have really been I think the top performer, at least in the asset classes that I'm involved in for the 10 years through 2022 and is also the top performer this year. So it seems like a bit of a momentum trade, but in the event that you do have sort of a softish landing and the CLO machine turns back on, I think there's still very big return potential in that market.

Matt Livas: It's very specific there, Brian, we'll be checking up on you 12 months time on the accuracy.

Brian Pacheco: inaudible matters, so I'll change my entry point if I have to. Yeah, always.

Matt Livas: Just a final question here. This is maybe a tough one here. One bold prediction for 2024 from each of you please.

Ricardo Adrogue: Mine is peace in our time. We have been going through tons of wars and if anything they may suggest that they will continue and get potentially worsened, but my prediction is peace in our time.

Yulia Alekseeva: I don't think I have anything as profound and optimistic as Ricardo. So I think rates will drive really the performance of the market for'24 and I think there is a little bit of a delay in Fed's decisions to what we're seeing. So I only expect one rate cut in'24, which is not the consensus. I think generally people have been pricing in way more rate cuts and I just don't think this will happen. I am in the camp of higher for longer,

Brian Pacheco: So my bold prediction, I guess this won't seem bold to Ricardo, but inflation drops below 2%. So said another way, it was transitory after all, transitory just took a really long time.

Yulia Alekseeva: That's a forever transition.

Matt Livas: All right, so we've had a few questions come in from our audience. I'm just going to ask each of you maybe one question. Let's have a look here. Ricardo, I'm going to start with you. Actually a question you touched on it earlier, but here's the question. In many cases EM local debt is now yielding less than developed markets debt. Shouldn't one expect a higher return for investing in riskier asset class?

Ricardo Adrogue: That's a great confusion I would say because when people talk about riskless, they're actually talking about credit risk and there's other risks as well. One is inter rate risk and currency risk. Local markets have the latter too, and to the extent that they are good credit quality the credit risk is almost non- existent. So another way of looking at it is the US yield curve a few weeks ago was close to the highest of all developed markets. Only New Zealand and Australia were higher than the US and there were five emerging markets that have the full yield curve below that of the US. The third element is the level of yield doesn't necessarily mean actual returns. And so good high yields a lot of times result in really lousy returns and vice versa.

Matt Livas: That's a good point. Brian, here's one for you. Ford was recently upgraded to investment grade. Does this mark the turning point for so- called rising stars and what are your expectations going forward around that rising star fallen angel dynamic?

Brian Pacheco: Yeah, that's a good question. I think Ford caught some people by surprise. It's about 3% of the high yield market. That was a pretty momentous event. I think it's important to go back and look at how fallen angels or rising stars conversely have shaped high yield over the last few years. In covid you had about two hundred billion or north of two hundred billion of fallen angels coming into high yield. So the market expanded. Since then, at least since the start of 2022, the market's contracted by around 350 billion. So 230 of that was rising stars. So you've had really the high yield market contract over the last year and a half and that's been a positive technical. Does Ford mark a turning point? Yeah, probably. It's over 40 billion of debt. So with Occidental and others having been upgraded already, it's the last kind of massive capital structure. So I do think it marks a turning point. Although similar to the trend you mentioned earlier in high grade, we still expect rising stars to exceed fallen angels in 2024. So you are continuing to get that tailwind, but it's going to be much less significant than it has been over the last 18 months.

Matt Livas: Thanks actually to all three panelists today. Thank you for joining as well. For everyone dialing in. Unfortunately we are out of time, so please also visit barings. com to read our latest thoughts from the investment teams around the firm. And as always, thank you for your continued partnership. Goodbye.

Greg Campion: Thanks for listening to this episode of Streaming Income. If you'd like to stay up to date on our latest thoughts on asset classes ranging from high yield and private credit to real estate debt and equity, make sure to follow us and leave a review on your favorite podcast platform. We're on Apple Podcasts, Spotify, YouTube, and more. We publish a new episode every other week. And if you have specific feedback, you can email us at podcastatbarings. com. That's podcast at B- A- R- I- N- G- S. com. Thanks again for listening and see you next time.