Head - Fixed Income Strategy
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Contrary to financial theory, stock and bond prices have rallied in tandem this year. We explore the outlook for fixed income yields across key markets.
When stocks go up, bond prices go down, right? While this may be what the financial textbooks tell us, stocks and bonds have chosen to disregard this historical relationship for most of 2019. Trade uncertainties and a synchronized dovish shift in central bank policies are largely responsible for the rally in global yields. We expect these themes to affect markets for some time, keeping pressure on core interest rates.
We expect the Federal Reserve to cut interest rates 25bp at their July 31 meeting. While market surprises are less frequent, the Fed has delivered dovish surprises twice as often as hawkish shocks. Beyond the July meeting, markets are still pricing in additional easing. If history is a guide, fixed income markets tend to perform well during periods of Fed easing. We remain overweight high quality US corporates and US Treasury debt (UST).
In our view, European Central Bank (ECB) policy is likely to have a more meaningful impact on global yields. We expect additional rate cuts later this year, along with a restart of their asset purchase program (APP). This is likely to weigh on net supply when 80% of the world's bond market (ex-US) already trades with a yield less than 1%. While currency strategies may offer value in certain low yielding euro bonds, we largely avoid negative yielding bonds.
We expect ECB APP to have a positive effect on credit spreads. With potential rate cuts lowering the risk of a summer pull back, we revise up our underweights on US high yield and European corporates (both HY and IG). We remain overweight US dollar (USD) emerging market (EM) debt, which still offers some of the best relative value in global fixed income. Especially in Asian corporates, where valuations are attractive relative to developed markets.
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