Plotting a course through volatile bond markets

22/01/2019

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​Nick Maroutsos, Co-Head of Global Bonds, explains why the US Federal Reserve (Fed) will likely not meet its 2019 interest rate target and how investors might position themselves for a more subdued rate path.

Until the summer of 2018, bond investors expected 2019 to be characterised by a continuation of gradual rate tightening by the Federal Reserve (Fed) and an upward shift along the front end of the US Treasury yield curve. Fiscal stimulus and strong economic data stood to push the yield on 10-year Treasuries above 3.0% for the first time since 2014. This scenario was reinforced by wages registering annual gains greater than 3.0% and Fed Chair Jerome Powell’s comment that interest rates were “a long way from neutral”, meaning markets could expect additional hikes. Spurred by these developments, rates rose across the curve during the autumn. It was not to last.

The late-year reversal in Treasuries and widening of credit spreads indicate that the market’s expectations for 2019 have changed considerably. While many factors have contributed to falling yields and a flattening curve, we consider the focal point to be the Fed’s expected interest rate path.

Plan A – out the window?

Investors expected higher interest rates for several reasons. Foremost, the Fed told us. The rationale behind forward guidance was to telegraph the future path of rates so as not to surprise markets. Many believed the Fed sought to increase its “dry powder” to better prepare itself for an economic downturn. Economic data also favoured continued tightening. US GDP growth for 2018 is forecast to reach 3.0%, driven by solid consumption and business investment. The uptick in wages reminded the Fed to be vigilant about inflation. Lastly, the extended business cycle led to rich valuations in risk assets such as stocks and corporate credits and deteriorating credit standards, developments the Fed could interpret as signs of an overheating economy.

What changed?

With the labour market at what many view as full employment, the need to keep rates low has dissipated. However, given the lack of inflation, there is scant reason to push forward on aggressive tightening. In fact, we believe that disinflationary forces have recently gathered steam. After reaching the Fed’s targeted level, core inflation has slid back below 2.0%, and annualised monthly data indicate this downward trend is accelerating. Should crude oil’s 30% late-year drop prove sticky, lower prices could leech into core inflation and could send the Fed’s favoured price gauge even lower.

Chart 1: Core PCE Index, three-month change annualised


Source: Bloomberg, as at December 2018. PCE = personal consumption expenditures.

While lower oil prices benefit many industries, drilling’s increasing role in the US economy could add a headwind to future growth prospects. But overshadowing the risk posed by oil are the trade disputes that have fuelled caution among companies as the future playing field of global commerce remains uncertain. This ambiguity has acutely weighed on China and the countries that are heavily intertwined in its supply chain.

Many of the autumn’s developments – from higher longer-dated Treasuries to a wobbly stock market – act as a form of fiscal tightening and, thus, may diminish the need for the Fed to maintain its recent pace. Furthermore, the Fed’s bias remains dovish, meaning that if it were to risk policy error, it would be to allow the economy to run hot for a finite period.  It is our view that the risk posed by slowing rate hikes has diminished as the economy is arguably positioned for a sustained period of non-inflationary growth.

Where to go

For much of the past two years, we considered holding US duration a risky proposition given the Fed’s removal of accommodative monetary policy vis-à-vis its developed market peers. In light of the widening range of outcomes for the global economy and the absence of inflation, we believe the 2019 prospects for Treasuries may not be as grim as originally expected. Should a slowdown in global growth occur or one of many potential sources of geopolitical risk ignite, Treasuries’ allure may further rise as investors seek traditional safe havens.

If investors choose to increase their Treasuries allocation, they still must be selective as to which tenors to target. The yield curve flattened significantly in 2018, with the spread between 10-year and 2-year notes sliding from 78 basis points (bps) in February to less than 12 bps by early December. Such a term structure provides investors little incremental return for the additional interest rate risk they take on when holding longer-dated securities. For this reason, we expect any push into Treasuries to be concentrated along the front end of the curve.

The return of an asset class

As recently as 2017, the appeal of holding shorter-dated Treasuries may have been limited given their low yields. That is no longer the case. The Fed’s nine rate increases pushed the yield on the 2-year note toward 3.0% before the late 2018 reversal in yields, up from 0.55% in 2016. Higher yields have buttressed the argument for shorter-dated bonds being their own asset class rather than a proxy for cash they were viewed as for much of the post-crisis era. Should the pace of rate hikes be curtailed, we consider it more likely that the yield curve experiences some steepening in 2019 as investors seek the stability – and yield – of shorter-dated Treasuries.

The alternatives

Conversely, a move into Treasuries would come at the expense of foreign bonds. We are, however, not there yet. Many regions lag the US in tightening, and a slowdown in global growth is likely to keep their policy accommodative for longer. Given their reliance on commodities and linkages to China, Australia and New Zealand fit into this category. These countries still offer attractive carry relative to the US, but increasing dovishness by the Fed may justify an eventual equal-weighting to US duration.

European sovereigns, with their low yields, are less desirable. The situation is exacerbated by the acute risk the region faces with Brexit, Italy’s budget stand-off and a leadership transition in Germany. While we do not expect the European Central Bank to institute another round of quantitative easing, we believe it will hold off on tightening until the outlook becomes clearer.

Risks remain

Futures markets expect only one rate hike in 2019 and none in 2020, well below the Fed’s median forecast. Should the market be proven correct, investors would likely have to deal with a weaker-than-expected economy.  Low-growth conditions would not be favourable for overburdened corporate balance sheets and the ensuing spread widening would add yet another reason for investors to seek the safe harbour of Treasuries.

Should the Fed’s view be right, the market would likely experience a snapback, much like what was experienced in October when yields rose across the curve. While not our base-case scenario, we believe the higher rate path could be driven by an upside surprise in inflation, either due to robust wage growth or tariffs resulting in higher-priced goods for US consumers.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Important information

Please read the following important information regarding funds related to this article.

Janus Henderson Absolute Return Income Fund

For institutional/ sophisticated investors / accredited investors qualified distributors use only.

All content in this document is for information or general use only and is not specific to any individual client requirements. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation or investment advice, nor should be taken as a basis to take (or stop taking) any decision.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying agents, it should be read carefully. An investment in the fund may not be suitable for all investors and is not available to all investors in all jurisdictions; it is not available to US persons.  Past performance is not indicative of future results. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements.  Shares, if redeemed, may be worth more or less than their original cost.

Janus Henderson Group plc and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regards to the results obtained from its use. As with all investments, there are inherent risks that each individual should address.

The distribution of this document or the information contained in it may be restricted by law and may not be used in any jurisdiction or any circumstances in which its use would be unlawful.

Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • This fund is designed to be used only as one component of several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Absolute Return Income Fund (EUR)

For institutional/ sophisticated investors / accredited investors qualified distributors use only.

All content in this document is for information or general use only and is not specific to any individual client requirements. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation or investment advice, nor should be taken as a basis to take (or stop taking) any decision.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying agents, it should be read carefully. An investment in the fund may not be suitable for all investors and is not available to all investors in all jurisdictions; it is not available to US persons.  Past performance is not indicative of future results. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements.  Shares, if redeemed, may be worth more or less than their original cost.

Janus Henderson Group plc and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regards to the results obtained from its use. As with all investments, there are inherent risks that each individual should address.

The distribution of this document or the information contained in it may be restricted by law and may not be used in any jurisdiction or any circumstances in which its use would be unlawful.

Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

Risk rating

Janus Henderson Absolute Return Income Opportunities Fund

For institutional/ sophisticated investors / accredited investors qualified distributors use only.

All content in this document is for information or general use only and is not specific to any individual client requirements. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation or investment advice, nor should be taken as a basis to take (or stop taking) any decision.

Janus Henderson Capital Funds Plc is a UCITS established under Irish law, with segregated liability between funds. Investors are warned that they should only make their investments based on the most recent Prospectus which contains information about fees, expenses and risks, which is available from all distributors and paying agents, it should be read carefully. An investment in the fund may not be suitable for all investors and is not available to all investors in all jurisdictions; it is not available to US persons.  Past performance is not indicative of future results. The rate of return may vary and the principal value of an investment will fluctuate due to market and foreign exchange movements.  Shares, if redeemed, may be worth more or less than their original cost.

Janus Henderson Group plc and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not guarantee that the information supplied is accurate, complete, or timely, or make any warranties with regards to the results obtained from its use. As with all investments, there are inherent risks that each individual should address.

The distribution of this document or the information contained in it may be restricted by law and may not be used in any jurisdiction or any circumstances in which its use would be unlawful.

Issued in Europe by Janus Capital International Limited (“JCIL”), authorised and regulated by the U.K. Financial Conduct Authority. Janus Capital International Limited (“JCIL”) is an entity registered and operating under the laws of the United Kingdom and Janus Capital Funds plc. is registered under the legislation of Ireland.

The extract prospectus (edition for Switzerland), the articles of incorporation, the extract annual and semi-annual report, in German, can be obtained free of charge from the representative in Switzerland: First Independent Fund Services Ltd (“FIFS”), Klausstrasse 33, CH-8008 Zurich, Switzerland, tel: +41 44 206 16 40, fax: +41 44 206 16 41, web: http://www.fifs.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For Qualified investors, institutional, wholesale client use only. Outside of Switzerland, this document is for professional use only. Not for onward distribution.

This material is strictly private and confidential and may not be reproduced or used for any purpose other than evaluation of a potential investment in Janus Capital International Limited’s products or the procurement of its services by the recipient of this presentation or provided to any person or entity other than the recipient of this presentation.

We may record telephone calls for our mutual protection, to improve customer service and for regulatory record keeping purposes.

Janus Capital Management LLC serves as investment adviser. Janus, Intech and Perkins are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. For more information or to locate your country’s Janus representative contact information, please visit www.janushenderson.com.

Specific risks

  • Some or all of the Annual Management Charge and other costs of the Fund may be taken from capital, which may erode capital or reduce potential for capital growth.
  • This fund is designed to be used only as one component of several in a diversified investment portfolio. Investors should consider carefully the proportion of their portfolio invested into this fund.
  • If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • Emerging markets expose the Fund to higher volatility and greater risk of loss than developed markets; they are susceptible to adverse political and economic events, and may be less well regulated with less robust custody and settlement procedures.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • The Fund invests in high yield (non-investment grade) bonds and while these generally offer higher rates of interest than investment grade bonds, they are more speculative and more sensitive to adverse changes in market conditions.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.

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