As the US Federal Reserve risks executing on an overly aggressive tightening path, and the economic and credit cycles continue to progress, Fixed Income Portfolio Managers Seth Meyer and Tom Ross highlight the importance of a nimble approach to fixed income.
What are the key themes likely to shape fixed income markets in 2019?
The number of interest rate hikes the Federal Reserve (Fed) pursues will have a substantial impact on global fixed income markets in 2019. The Fed has accomplished its goals of maximum employment and stable prices, and while it will seek to maintain those targets, it does not wish to push the US economy into recession. Given that fiscal stimulus, not monetary policy, is currently sustaining growth, and that the impact of each hike is subject to a multi-month time lag, we could see fewer hikes than the Fed is currently forecasting. Still, uncertainty exists in terms of the variability of outcomes for the US economy, and we are beginning to hear companies express that concern. The unwavering confidence we have seen from management teams since 2015’s mid-cycle correction is fading. As companies weigh the potential economic outcomes, we expect to see more cautious risk taking in 2019 and less-aggressive earnings forecasts.
Where do you see the most important opportunities and risks within your asset class?
If the Fed pulls back and moderate GDP growth continues, the roughly 7%* coupon on US high yield looks attractive. However, we are prepared for modest spread widening as investors acknowledge comparatively slower earnings growth versus 2018. Given the rising-rate environment and generally diminishing prospects for spread tightening, short-duration high yield remains an attractive source of income.
Positive trade developments between the US and China could send risk markets to new heights. Given the uncertainty, however, we believe US-centric companies in sectors with deleveraging trends, such as pharmaceuticals and health care, present attractive risk-adjusted opportunities. In our view, deleveraging and favourable supply/demand dynamics for certain base commodities will ultimately outweigh trade-related volatility for select metals and mining issuers. The consumer and its desire for experiences should be a source of opportunity as relatively large tax refunds should spur spending in the first half of the year.
European high yield valuations have become more favourable and the region continues to offer more attractive value on a risk-adjusted basis compared to the US. There has been a high level of dispersion among European names and we expect that to be an ongoing source of opportunity for our research-driven approach.
How have your experiences in 2018 impacted your approach or outlook for 2019?
2018 highlighted the importance of blending bottom-up, fundamental security selection with a structured top-down view. The Fed is actively tightening, the economic and credit cycles are in extended innings, and volatility is returning to markets. As we monitor the signals flashing from these and other macro factors, we must maintain the discipline to shift our allocation when asset classes become more or less attractive. A nimble approach, in which we can dynamically allocate to the team’s best ideas in the strongest risk-adjusted parts of the market, should help us to dampen portfolio volatility and better weather any storms that may arise.
*Source: Bloomberg, ICE BofAML US High Yield Index, yield to worst, at 22 November 2018. Yield to worst is the lowest possible (worst case) yield assuming no defaults; it takes into account issuer features that might exist on bonds such as any prepayment provisions or rights to call a bond early, which might detract from the yield.
Yields may vary and are not guaranteed.
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