Head - Fixed Income Strategy
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With low interest rates here to stay for now, we highlight some of our highest conviction fixed income markets.
As the smoke from last month’s fire sale clears, bond markets are left with lower risk-free rates and wider credit spreads. In certain higher-risk assets, valuations are downright cheap. However, we express some caution as the public and personal impact surrounding the Covid-19 pandemic has likely translated into one of the deepest economic contractions in modern times. We remain focused on keeping portfolio quality high and preparing for what could be a volatile time ahead.
We expect the US Federal Reserve to keep policy rates at the zero bound for the foreseeable future. Futures markets currently imply a mere 15bp worth of rate hikes through 1Q 2023. It’s unlikely we see the Fed raise rates before the unemployment rate drops dramatically. This could take a couple of years at a minimum. Long-term rates may eventually come under pressure as virus fears abate and Fed purchases slow. With short rates anchored, the yield curve is more likely to steepen.
The severe dislocation that credit markets endured last month has largely been resolved. With the low hanging fruit now gone, investors are still left with cheap valuations. Though secondary market liquidity has improved, it’s far from normal. New issuance has become an easier venue to source bonds, with corporations taking advantage at a record-breaking pace. In many instances, lower Treasury yields has resulted in attractive “all-in” financing for issuers, despite wider spreads.
We maintain our high conviction in US investment grade (IG) corporates. At the same time, rate differentials between the US and Europe have narrowed significantly, increasing the value proposition for non-US bonds. We stay neutral high yield for now, though history does suggest a long-term opportunity is present. However, this may be more so in bonds than HY bank loans. For US investors, municipals remain cheap across the entire curve.
Read Bond Market Monthly.