Head - Fixed Income Strategy
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With the coronavirus threatening global growth and Treasury yields dropping again, we consider the implications for fixed income allocations.
The risk that an acceleration in the COVID-19 (coronavirus) outbreak can significantly affect global growth has increased meaningfully. Though still unlikely, US recession risks have risen, the yield curve has inverted and markets have priced in two full rate cuts for this year.
Fed policy may ultimately be dictated by the path of the virus outbreak, which is unpredictable. However, we believe the committee may take the path of least resistance and follow market expectations. Whether the Fed cuts now, later or never, short-term US rates are likely to remain low (or move lower). With the US yield curve inverted, hedging floating-rate liabilities beyond the short-term is more attractive.
In regard to 10-year Treasury yields, if the virus cannot be contained, the recovery from last year’s trade shock will be derailed. This could lead to a weakening macro outlook, downward earnings revisions and higher equity volatility. This would likely intensify the demand for safe haven assets. If the flu pandemic intensifies to the US, we would not rule out the possibility for 10-year UST yields to fall to 1.25%, or lower.
We continue to favor having exposures to longer duration high quality bonds, primarily in US IG corporates. In high yield, pressure may continue if virus fears accelerate. We prefer to maintain an up-in-quality bias in senior secured bank loan debt, which tends to be better protected to the downside. We see consumer-based asset-backed securities as attractive way to diversify portfolios and enhance yield. Non-agency residential mortgage-backed bonds remain our preferred market. We also remain overweight external emerging market debt and continue to find value in longer-dated municipals, for US-based investors.