Jim Cielinski, Global Head of Fixed Income, provides his perspective on some of the key macroeconomic factors that are driving fixed income markets.
- Moving beyond ‘peak liquidity’ will define markets in 2019.
- Politics elevates the probability of ‘bi-modal’ outcomes.
- Late-cycle corrections are creating value in selected areas.
- The yield curve signals a slowdown but not necessarily a recession.
What do you expect to be the defining characteristics of 2019?
2019 is really a story about peak liquidity and the fact that we have now ended what was a hugely positive environment. You have had QE low rates has propelled almost everything upward. As we unwind that, I don’t think people really know what might happen and this is a liquidity cycle, I think, driven marketplace, more than a standard economic driven marketplace. And that is a big difference. It is going to matter a lot for volatility and asset markets.
Has the risk of a policy error by the Federal Reserve receded?
I do think the risk of the Federal Reserve overshooting and tightening too much has faded. They don’t really know how far to tighten and I think their recent comments about the market volatility, the slowdown that is now global, I think it has entered their minds and I do think they will be quite cautious. Now they have already moved a lot though and there is a lot of debt. There are issues now emerging on the political front, so I think all of these might still mean that they have tightened by perhaps too much if these other things are catalyst for our further slowdown.
Will politics play a role of outsized importance in 2019?
Politics is probably more important today than any time I can think of in my career. We have trade, I include that in politics, Brexit, Italy, a number of things on the political front in the US. These are important. Unlike many events that are kind of ripples in a pond, we are talking about things now politically that could have far-reaching ramifications. And for me, that makes it hard to say there is a central case. Many of these are either going to be good or bad. And the in between is what you may not get. For markets, that is really important to understand.
Where are we in the credit cycle?
We believe that the credit cycle has turned. And by that we mean that defaults have probably bottomed, spreads, credit spreads relative to government bonds have probably bottomed and more stress lies ahead. Does it mean a 2008 type of event? No, it doesn’t, but it does mean more stress, I think less ability to grow through debt, and for me it does mean more challenging returns in some parts of the market. With that said, we have moved to levels that reflect a lot of this new reality, so it doesn’t mean there isn’t value to be gained from looking at credit quite closely, but I think the best days in the cycle are behind us.
Taking a global mindset, I look at many markets and European credit might be one where it is fairly far advanced. The underperformance has been marked against the US this year for example. And yet they are actually earlier in the cycle. So provided that growth can remain at least moderate and Italy doesn’t cause a crisis situation to evolve, I would actually see a lot of opportunity doing cross market trades. That is perhaps favoring Europe against the US and things like that in the coming year. The cycle differences, again, are real and I think the political risks are real. So lots of different drivers I think globally and less unison in the way we should think of a cycle unfolding.
Is the flattening/inversion of the US yield curve a concern?
I think whenever you see an inverted yield curve, you must look at history and say it is meaningful. It doesn’t cause a recession, that is an important point and that has dominated headlines. What it does do is reflect a market expectation that things will slow down in the future. I think it pays to look at that and respond as though that is likely to happen. The bond market overall is a good predictor and I think the slowdown is likely to unfold for that reason. We probably shouldn’t get too carried away and say a recession is just around the corner, because of the very modest inversion. And I would stress it has very modest in parts of the yield curve.
Is volatility creating more value?
Volatility is both the friend and the enemy of active managers. It creates value, it creates risk, right? So for me, I don’t think of volatility as necessarily good or bad. It should be good though if you have an active management skillset that allows you to look over the globe and pick those spots that volatility has maybe pushed things down too far, identify where you might have over valuations. Volatility to me is here to stay, that is a key component of the end of the liquidity cycle. So for me there are lots of opportunities. I am excited by it, but you always have to say it is both a risk and an opportunity.
The opinions and views expressed are as of December 2018 and are subject to change without notice. They are for information purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security, investment strategy or market sector. No forecasts can be guaranteed. Opinions and examples are meant as an illustration of broader themes and are not an indication of trading intent. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. Janus Henderson Group plc through its subsidiaries may manage investment products with a financial interest in securities mentioned herein and any comments should not be construed as a reflection on the past or future profitability. There is no guarantee that the information supplied is accurate, complete, or timely, nor are there any warranties with regards to the results obtained from its use. Past performance is no guarantee of future results. Investing involves risk, including the possible loss of principal and fluctuation of value.
Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.
Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.
Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. The principal on mortgage- or asset-backed securities may normally be prepaid at any time, which will reduce the yield and market value of these securities. Investing in derivatives entails specific risks relating to liquidity, leverage and credit and may reduce returns and/or increase volatility.
Credit Spread is the difference in yield between securities with similar maturity but different credit quality.
Quantitative Easing (QE) is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market
Janus Henderson and Knowledge. Shared are trademarks of Janus Henderson Group plc or one of its subsidiary entities. © Janus Henderson Group plc.
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Global Fixed Income Compass
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