Key takeaways:
- Artificial intelligence (AI) driven capital spending (capex) is reshaping credit markets. Increased funding needs are lifting supply pipelines, particularly in U.S. investment grade, pressuring spreads and limiting valuation upside despite strong fundamentals.
- By contrast, agency and commercial mortgage-backed securities we believe offer a more favorable technical backdrop, supported by a broad buyer base and strong liquidity.
- Heightened rate uncertainty is a key risk, caused by an on-off U.S.-Iran truce, a less communicative Federal Reserve (Fed) and the inflationary aspects of the AI buildout. This leads us to favor short duration and floating rate assets, such as securitized and loans, over more interest rate-sensitive corporate bonds.
Rate uncertainty favors short duration and floating rate assets
A ‘Memorandum of Understanding’ between the US and Iran led to an on-off ceasefire, which, together with softening in the oil price, helped risk assets to recover from lows earlier in the year. Concerns about inflation linger, however, with artificial intelligence (AI)-led investment spending lifting growth and driving sustained funding needs across capital markets, notably investment grade bonds. The European Central Bank raised interest rates and the U.S. Federal Reserve (Fed) under its new Chair Kevin Warsh removed forward guidance. Reduced visibility into the Fed’s policy path leads us to prefer the relatively stable carry offered by securitized assets, while retaining a highly selective approach to corporates.
Yields across fixed income asset classes continue to appear attractive relative to the past decade. Spread levels are toward the tighter end of their ranges, albeit relatively more attractive among securitized assets.
Within corporate credit, relatively full valuations are supported by resilient growth, easing geopolitical tensions, strong corporate profits, and a broadly stable consumer backdrop, although AI-related borrowing may limit valuation upside within investment grade corporate bonds. By contrast, agency and commercial mortgage-backed securities we believe offer a more favorable technical backdrop. We favor securitized credit and loans over corporate bonds and Emerging Market (EM) debt, however, because convexity is likely to be less valuable in an environment where carry is likely to be an outsized driver of returns. In our view, short duration and floating-rate assets are attractive in a more uncertain Fed regime, where reduced policy visibility may drive demand for instruments with lower sensitivity to rate volatility.
In our quarterly “Perspectives” document we share our views on the fixed income market and our quarterly asset allocation rankings. We highlight a timely chart to watch, explore relative value opportunities, and provide insight on our latest asset allocation scores by fixed income sub-sector.
IMPORTANT INFORMATION
Fixed income securities are subject to interest rate, inflation, credit and default risk. As interest rates rise, bond prices usually fall, and vice versa. High-yield bonds, or “junk” bonds, involve a greater risk of default and price volatility and can experience sudden and sharp price swings. Foreign securities, including sovereign debt, are subject to currency fluctuations, political and economic uncertainty and increased volatility and lower liquidity, all of which are magnified in emerging markets.
Securitized products, such as mortgage- and asset-backed securities, are more sensitive to interest rate changes, have extension and prepayment risk, and are subject to more credit, valuation and liquidity risk than other fixed-income securities.
Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.
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Janus Henderson Investors makes no representation as to whether any illustration/example mentioned in this document is now or was ever held in any portfolio. Illustrations shown are for the limited purpose of highlighting specific elements of the research process. The examples are not intended to be a recommendation to buy or sell a security, or an indication of the holdings of any portfolio or an indication of performance for the subject company.