Fixed Income 2018 SPECIAL REPORT - Investment Management
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FOR PROFESSIONAL CLIENTS AND, IN SWITZERLAND, FOR QUALIFIED INVESTORS ONLY. IN ISRAEL FOR SOPHISTICATED INVESTORS ONLY.
2018
Fixed
Income
SPECIAL REPORT
Fixed Income/Q1 2018
SPECIAL REPORT
Contents
4
New horizons
BNY Mellon investment boutiques* Newton, Insight
Investment, Alcentra, Mellon Capital and Standish
outline the backdrop for fixed income markets in the
opening half of 2018.
12
Winds of change
BNY Mellon boutique portfolio managers and analysts
assess both the opportunities and risks investors face
across a range of fixed income sectors and strategies in
the year ahead.
22
Rising stars and fallen angels
Insight Investment’s high yield manager Ulrich Gerhard
looks at opportunities presented by a possible
continuation of corporate upgrades.
23
Building value
The Standish municipal bond investment team explains
the market for ‘munis’ and explores the latest trends
driving change in the sector.
24
Premium blend
Insight Investment head of emerging market debt Colm
McDonagh surveys the emerging market debt landscape
and possible sources of risk premium.
*Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited
(BNYMIM EMEA) or affiliated fund operating companies to undertake portfolio management
activities in relation to contracts for products and services entered into by clients with
BNYMIM EMEA or the BNY Mellon funds.Introduction
W
ile global markets witnessed considerable
h
volatility in early 2018, fixed income
investors have continued to find some
genuine grounds for optimism. The start of the year
saw few signs of stress in credit markets despite
indications of wider interest rate renormalisation.
In January the International Monetary Fund (IMF) upgraded its global
growth forecast to 3.9% after an improvement last year that saw 120
countries achieve stronger year-on -year growth in the broadest upward
trend1 since 2010.
With this trend expected to continue, the IMF believes the proposed
US$1.5 trillion US government tax reform will help boost both the domestic
economy and broader global markets, though it also expects its benefits to
be short-lived.
In this, the fifth edition of our BNY Mellon Fixed Income Special Report,
we explore the impact of strengthening global growth prospects and other
key trends driving change across the asset class. Events set to impact bond
markets this year include the phased withdrawal of global quantitative
easing (QE) programmes, the return of inflationary pressures and wider
geopolitical factors.
A largely buoyant 2017 saw global bond funds attract about US$350bn,
investment grade bond vehicles attract US$277bn2 and emerging markets
fixed income enjoy a wider renaissance. Nevertheless, some now wonder
whether recent inflows and return levels can be sustained in the months
ahead and if valuations now look stretched.
Against this backdrop, managers across BNY Mellon boutiques, including
Standish, Newton, Alcentra, Insight Investment and Mellon Capital, outline
the prospects facing the fixed income market in the year ahead, assessing
what investors might expect and where opportunities may lie.
Regardless of some of the prevailing macro concerns or pressures and
some renewed bouts of market volatility, these managers say they expect
to see positive opportunities and selective pockets of value continue to
emerge across the fixed income universe throughout 2018.
1 The Guardian. IMF lifts global growth forecast to 3.9%, saying momentum is building. 22 January 2017.
2 FT. Hidden gyrations underpin 2017 global fund flows. 22 December 2017.
Introduction3Fixed Income/Q1 2018
New
horizons
H
elped by a synchronised upswing across both developed and emerging
markets, the signs appear positive for global growth in the coming
year, say managers and experts from across BNY Mellon’s investment
boutiques, although not all agree the investment horizon is free from risk.
4 New horizonsAt first sight, the outlook for fixed income initially followed by a likely downturn as
investors in the coming months appears the year progresses.
THE WORLD
benign. Every one of the world’s 45 major
IN NUMBERS economies tracked by the Organisation for Here, he points to the winding back of
Economic Cooperation and Development stimulus as one of the potential triggers
3
The number of US Federal
(OECD) is expected to grow in 2018.
In a similar vein, amid favourable IMF
as central banks sell bonds and tighten
the money supply. In this sense, the US
Reserve-mandated interest rate Federal Reserve (Fed) is already beginning
growth forecasts, 46% of global leaders
rises forecast in 2018. to make an impact, as it begins to run down
interviewed as part of The Conference
its US$4.2 trillion portfolio of Treasuries
Board’s annual CEO confidence survey
0.9%
The increase in yield on
said they expect economic conditions to
improve over the first half of 2018.1
and mortgage-backed securities at the
rate of US$10bn a month. “As we move
three-month US Treasuries into 2018, the Fed will increase the pace
between January 2017
Against this background, the level of of rationalisation by US$10bn every three
and January 2018.
debt in the world has continued to grow. months until it reaches a monthly rate of
According to the Institute of International US$50bn,” says Brain. “Meanwhile, the
0.1%
The equivalent increase for
Finance, global debt rose to a record
US$233 trillion in the third quarter of
European Central Bank has halved its
bond purchases to €30bn starting January
10-year US Treasuries over
2017, more than US$16 trillion higher than 2018 and is expected to end QE purchases
the same period.
end-2016. New issuance – particularly in entirely by September. Inevitably, if loose
emerging markets – was one of the year’s policy helped stimulate the global economy,
US$6.8 trn
Value of new bonds issued in 2017.
main themes: new bonds raised a record
US$6.8 trillion, with corporates accounting
its withdrawal will do the reverse.”
Corporates accounted for
55% of that total. for 55% of that total.2 Bond bear wake-up call?
With QE tapering and balance sheet
QE: beginning of the end rationalisation very much on the cards, the
2%
Expected default rate on high
For Newton’s head of fixed income Paul
Brain, the synchronised upswing in the
question then is whether the coming year
could be a tipping point for bond pricing.
yield bonds to the end of 2018,
according to ratings agency Fitch. global economy can be attributed at least
This would be the lowest level of
Certainly, many segments of the fixed
in part to the extraordinary monetary policy
defaults since 2013. income universe look expensive relative
put in place since the financial crisis. “For to long-term value, leading many
the past couple of years it’s been all about
165%
The level of corporate debt
pro-risk and pro-asset prices,” he says, “and
we think that’s largely due to central bank
commentators to argue a correction may
be overdue. Spreads for high yield and
investment grade bonds, for example,
versus GDP in China. This is
“consistent with a high probability
intervention.” Nevertheless, he says, the remain well below the 15-year average.3
of financial distress,” according global economy is performing a balancing
to a report by the IMF.
act and he expects 2018 to be “a year of For April LaRusse, fixed income investment
two halves” marked by continued growth specialist, Insight Investment, the winding
1.5%
Expected UK GDP growth in 2018,
GDP FORECASTS, YEAR-ON-YEAR (%)
according to the IMF. The UK is
the only top-10 global economy
4.0
expected to have slowed in
both 2017 and 2018. 3.5
3.0
2.5
2.0
1.5
1.0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
17 17 17 17 17 17 17 17 17 17 17 17 18
Eurozone World US UK
Source: Bloomberg, 15 January 2018.
1 The Conference Board: CEO Confidence Rebounds. 04 January 2018.
2 Business Insider. Corporate borrowing drives global debt issuance to a record $6.8 trillion in 2017.
19 December 2017.
3 Charles Schwab. 2018 market outlook.11 December 2017. New horizons 5Fixed Income/Q1 2018
US TREASURY YIELDS, JANUARY 2017 V JANUARY 2018 yield curve and how it responds to
expectations of changes in central bank
policy. Yield curves generally flattened
3.5
through the course of 2017, he says, with
3.0 Europe the main exception to this trend.
2.5 He adds: “Europe is the last major market
2.0 to respond and there’s clearly a case for
the curve to flatten, which we believe
1.5
should be helped by ECB policy.”
1.0
0.5 The liquidity question
3M 6M 1Y 2Y 3Y 4Y 5Y 7Y 8Y 9Y 10Y 15Y 20Y 25Y 30Y
On liquidity, both Brain and LaRusse
100
agree the scaling back of QE should be
80
beneficial for government bond markets
60 but they also point out liquidity has been
40 more of a concern in credit markets
20 rather than in sovereign debt. Even here,
0 says LaRusse, it was less a question of
-20 whether there was availability and more
-40 a question of how much investors were
3M 6M 1Y 2Y 3Y 4Y 5Y 7Y 8Y 9Y 10Y 15Y 20Y 25Y 30Y paying for corporate bonds.
US Treasury Last Mid Yield US Treasury 01/01/17 Mid Yield
Yields on short-dated bonds have risen more steeply than yields on longer-dated bonds over the past year.
For Brain, liquidity could continue to
be a concern in 2018, especially given
Source: Bloomberg, 15 January 2018. the high level of likely redemptions in
credit markets in the coming months as
down of QE will put upward pressure on say we’re still dancing even as we edge
debt matures. Here, though, he points
government bond yields and possibly towards the doorway – the theory being
to a possible reduction in US financial
credit yields. Even so, she remains you can get through that exit before
regulation as a possible balancing factor
broadly upbeat about future pricing, everyone else if things do head south.”
should the White House follow up on
arguing for a modest sell-off reflecting
In practical terms, says Brain, that means President Trump’s campaign promises.
tighter monetary policy and the end of the
the Newton team still participates in This could potentially allow banks to
period of ‘lower-for-longer’, rather than
higher risk areas such as high yield and increase fixed income market-making
any stampede for the exits.
emerging market bonds but is offsetting activity once more, which in turn could
One exception is European government that with increasing exposure to have a positive effect on liquidity.
debt, which LaRusse describes as government bonds.
“[Insight’s] least favourite market”. Political risk
She explains: “We do think European Insight head of global rates and deputy If 2016 can be characterised as the year
government yields are far too low given head of fixed income, Andrew Wickham, is of the populist backlash, 2017 was all
how good things are in the European taking a similar tack. He anticipates more about risks that failed to materialise as
economy. One of the main reasons for this challenging market trading conditions for first the Netherlands, then France and
is the intervention of central banks and fixed income investors as QE dwindles finally Germany opted to maintain a
once that ends we expect to see those and he believes investors will reduce version of the status quo. How 2018 will
historic lows reverse. It’s a market where permanent exposures to the market. fare remains an open question.
we think short opportunities abound.” Even so, he says, that does not mean
the absence of opportunity. “We’re still In Europe, Brain points to the Italian
In contrast, Brain highlights the flattening looking for opportunities and risks that are election, due by May 2018, as a possible
yield curve as a potential precursor of mispriced – be they in inflation, interest risk should it bring the populist Five Star
worrying times ahead. Eventually, he rates or credit but perhaps not necessarily Movement to power. In Spain, likewise,
says, higher borrowing costs and higher taking the directional risk of the underlying calls for Catalan independence are
wages will influence the leveraged market. We believe there are still plenty of unlikely to fade. However, a bigger risk,
corporate sector and risk assets will be good investment opportunities out there he says, is not the likelihood of anti-
hit, ultimately causing a recession. For because we continue to see assets we feel establishment parties gaining power
the time being, he says, “robust growth are mispriced.” but the extent to which their policies will
numbers and low costs will keep the influence the mainstream even from the
music playing” but he also believes For Thant Han, portfolio manager at sidelines. This was the case in the UK
timing the transition will be key in 2018. fixed income specialist Standish, one with the UK Independence Party and in
“The analogy is with a party. We like to key metric for the coming year is the Spain with Podemos, he says, and could
6 New horizonscontinue to be a theme. “The prolonged Paul Hatfield, president of specialist For Alcentra’s Hatfield, US rate rises “look
period of wealth inequality means loans provider Alcentra, takes a more to be baked in” and any major variation
populism is here to stay,” he warns. nuanced view. He believes the tax reforms from the anticipated rises “would be
could be one of the overarching trends considered a shock”. Less cut and dried,
In the US, November’s midterm US and factors likely to influence markets he agrees, is the story with the eurozone.
elections will see 33 Senate seats and in 2018 but he also questions their wider “How the ECB handles its own tapering
all 435 House seats up for grabs. A big impact on society. He explains: “We think will be important,” he says. “The bank
win for Democrats could paralyse the it’s debatable whether this will just be has been very good at telegraphing its
White House legislative agenda, although a benefit for the rich and could trigger movements so far and has left itself
neither LaRusse nor Brain expect the share buybacks rather than getting
considerable room for manoeuvre. That
Democrats to gain control of both houses. investment into the real economy. Time
said, any sudden interest rate movements
will tell.”
could still be cause for a surprise.”
In the UK, meanwhile, Brexit uncertainty
is likely to remain front and centre, with Inflation: on the rise? Standish’s Han takes a similar view.
the IMF predicting growth to slow from With oil now well above the US$50-a- “There’s now a clear expectation
1.8% in 2016 to 1.7% in 2017 and to 1.5% barrel mark, earlier fears around deflation renormalisation will occur at some point
in 2018 as a result. This marks the UK as as a threat to the global economy now and the pace of that could determine
the only top-10 global economy expected appear a long-distant memory. Indeed, how riskier assets respond,” he says.
to slow in both 2017 and 2018. 2018 may be marked out as the year “In the past we’ve seen so-called taper
of price rises, particularly in the US tantrums create small bouts of volatility.
For both Brain and LaRusse, the UK
as tax cuts, the slow build-up of wage It’s not our base case that the ECB will
is ‘on hold’ until at least some of the
pressure, and potential changes to trade make the mistakes the Fed did previously,
uncertainties around Brexit are resolved.
relationships all converge to push up the which helped trigger the ‘tantrums’ but it
Says LaRusse: “A couple of quarters ago
prospect of inflation. is a concern – especially given how rich
we were surprised at how well things
valuations are in most European fixed
were holding up in the UK – particularly In the US, the Fed is forecasting as many income markets.”
in terms of consumer spending – but as three interest-rate increases in 2018
the longer the uncertainty around Brexit after three rises in 2017. In the UK, where Outside of the US and Europe, Japan
lasts, the more of an impact there is likely the consumer price index hit an annual remains something of an outlier: in spite
to be.” Essentially, she says, UK bond 3.1% increase in November, the Bank of of full employment and the highest job-
investors will have to wait for clarity about England’s base rate hike (by 0.25% to to-applicant ratio since the mid-1970s,
the direction of Brexit negotiations before 0.5%) was its first such move in a decade. inflation remains well below the Bank of
they can know with any certainty where Japan’s 2% target.4
things are heading. In the euro area, despite strong headline
growth numbers, the European Central For Brain, a big question on Japan for the
On the legislative front, President Trump Bank (ECB) appears marginally less coming year is whether the central bank
successfully enacted sweeping changes bullish, committing only to slow decides to move the interest rate above
to the US tax system at the end of 2017. It bond purchases made under its QE the 0% mark. There is speculation, he
remains to be seen whether the reduction programme but refusing to raise interest says, that a prolonged period of inflation
of the corporate tax rate from 35% to 21% rates for now. above 1% could provide a mandate to
will unleash significant new investment,
job growth and wage increases as the CONSUMER PRICE INDICES (%)
measure’s proponents have argued. In
Brain’s view, however, lower taxes mean 3.5
US companies will have more of their own
3.0
cash for buybacks and dividends and so
2.5
will have less of a need to raise debt.
2.0
LaRusse is more bullish. In her opinion, 1.5
tax rebates are part of a broader set of 1.0
tailwinds in the US that will provide a
0.5
shot in the arm for both consumers and
0.0
companies. “The US economy is already
doing better than expected and tax -0.5
reform will boost growth further,” she -1.0
Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec
says, “particularly if the government also
16 16 16 16 16 16 17 17 17 17 17 17
loosens its debt ceiling and therefore
US Eurozone Japan UK
spends more money on areas such as
defence and infrastructure.” Source: Bloomberg, 15 January 2018.
4 Bloomberg. Japan inflation picks up in November but still well below target. 25 December 2017. New horizons 7Fixed Income/Q1 2018
raise rates. His view, however, is that the GOLD (US$/TROY OUNCE, LHS) VS. WEST TEXAS INTERMEDIATE
central bank will “probably want to keep (US$/BARREL, RHS)
rates as low as possible for as long as
possible – and this makes sense given the
amount of debt on their balance sheet.” 1,400 70
On a broader note, Brain says he believes 60
1,350
global inflation will “continue to creep up
50
in 2018” and he says the Newton fixed 1,300
income team maintains a position in US 40
TIPS to guard against inflation while also 1,250
30
building a position in European inflation-
1,200
linked securities. Here, he says, while 20
Europe still has low capacity utilisation 1,150 10
compared with the US and is yet to reach
full employment, he expects inflation 1,100 0
expectations to rise eventually. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
17 17 17 17 17 17 17 17 17 17 17 17 18
The theme of slow but steady rate rises Oil (WTI US$) Gold (Troy ounce US$)
is one echoed by Paul Benson, head of
fixed income index and multi-factor fixed Source: Bloomberg, 15 January 2018.
income at Mellon Capital. “Rate hikes are
occurring at a very gradual pace and have Defaults and covenants companies will make enough money to
been well signalled to markets,” he says. meet those costs and we expect some of
On the defaults front, the spike of energy
“We don’t believe they will trigger any them to struggle, particularly in the retail
sector defaults driven by plummeting oil
massive further upset in the near term and the telecommunications sector.”
prices from 2016 appears to have eased.
and our view is that the anticipated hikes
Ratings agency Fitch has said it expects A potentially benign default environment,
are coming for solid reasons.”
the default rate on high-yield bonds to
coupled with an ongoing thirst for
LaRusse takes a similar view of gradually decline to 2% by the end of 2018, the
yield from the likes of pension funds,
rising inflation and notes that in the lowest level of defaults since 2013.
endowments and other investors,
absence of an unexpected commodity
For Brain, this is unsustainable and on appears to have its effect on covenants
price shocks or trade policies that
a company level he expects defaults to too, particularly in the high yield space.
radically increase import costs, the
picture on inflation is likely to remain rise. “Again it goes back to our view that In June, Moody’s Covenant Quality Index
relatively benign. 2018 will be a year of two halves. You’re hit its worst level since the company began
going to have companies whose business calculating the measure in 2011.5 Brain
At the same time, she also highlights a models are already challenged that describes this as “classic bond market
modern anomaly, namely the failure of will experience rising wage costs and behaviour”. “Covenants won’t really tighten
salaries to reflect the pace of job creation. rising borrowing costs. Not all of those until we have a crisis,” he says.
“At this level of growth, for this long,”
she says, “we would have expected both
wages and prices to have risen far faster SYNDICATIONS, US$BN YEAR TO DATE
by now. The puzzle is why these increases
haven’t materialised in the world’s leading 80
economies.”
Part of the explanation, she says, is 64
the inability of official data to provide a
comprehensive account of workers who
48
had earlier withdrawn from the labour
market. “What’s happening is that older
people and women are now coming back 32
into the workforce either because they
have to or choose to,” says LaRusse.
16
“That’s providing additional low cost
labour and so creates additional slack in
the labour market and lessens pressure 0
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
on wages. It’s a global phenomenon and
isn’t just restricted to the US.” Source: FT, Dealogic, 13 November 2017. For illustrative purposes only.
8 New horizons 5 Reuters Breakingviews. Yield junkies. 29 December 2017.Emerging markets
For emerging markets (EM), 2017 was For Carl Shepherd, Newton’s head rates, and since Ukraine is one of the
a bumper year. Pricing on EM bonds of emerging market debt, 2017 saw next traditionally high yielders (along
remained robust even in the face of numerous examples of EM debt markets with Argentina) the spreads have become
the ECB beginning to wind back its becoming dislocated from the reality of unjustifiably compressed.”
QE programme and the treble hit of their ability to pay. He notes, for example,
US interest rate rises. Those fearing a how some 2021 US dollar Argentinian Outside of Europe and Latin America,
repeat of 2013’s taper tantrum were debt had a spread of less than 200 basis China remains a key preoccupation
proved wrong. points (as at 12 December 2017), over for EM fixed income watchers. In its
US Treasuries despite domestic inflation December health-check of the world’s
Even as pricing held up, demand for of around 28% and the kind of weak second largest economy, the IMF noted
EM issuance rocketed, most notably fundamentals you might expect to see how the country’s credit growth has
on the sovereign front. Saudi Arabia from a single-B issuer. outpaced its economy in recent years.
raised US$12.4bn in September and Corporate debt now stands at 165%
Argentina raised some US$13.4bn Likewise, average Ukrainian government of GDP, it said, albeit from a low base,
across four tranches in the space of bond spreads were at around 374 basis while household debt has risen by 15
the year. Notably, one of these was points (as at 12 Dec 2017), he notes. percentage points of GDP over the
for a 100-year bond, which was 3.5 Again, this is despite Ukraine being in past five years. This is “very high by
times oversubscribed – a remarkable danger of losing funding from bilateral international standards and consistent
achievement given the country’s and multilateral lenders such as the with a high probability of financial
relatively poor record on defaults. IMF, the EU and the US due to the scant distress”, according to the report.8
progress at curbing corruption and the
Elsewhere, examples of sovereign high chokehold oligarchs have in domestic Brain says one of the key challenges
yield issuance in 2017 included Bahrain politics and the economy. for 2018 may be whether Chinese
(US$3bn), Tajikistan (US$500m), Iraq authorities can continue to successfully
(US$1bn) and Ukraine (US$3bn).6 Says Shepherd: “To my mind, this is driven rebalance the economy away from
Together with other issuance, this brought by demand from money which is too export-reliant manufacturing in favour
the total of emerging market debt raised wary to invest in Venezuela where it is of a consumption-based model driven by
in the 12 months to a record US$670bn.7 nigh on impossible to work out recovery services and innovation.
6 FT. Riskiest countries are selling debt at record rate. 13 November 2017.
7 Reuters. Emerging market deal making fees set for record US$200m. 20 December, 2017.
8 IMF. IMF Executive Board Concludes Financial Sector Stability Assessment with China. 06 December 2017. New horizons 9Fixed Income/Q1 2018
Perceived threats to bond markets in 2018
Threats Alcentra Insight Mellon Capital Newton Standish
Inflation
Liquidity shock
Geopolitical events
Volatility
Interest rate rise
Energy and commodity prices
KEY Very low Low Neutral High Very high
VARIANCE OF BEST PERFORMERS
BESTWORST
EM HY IG Govt
2017
9.2 6.7 4.6 1.1
HY EM IG Govt
2016
15.7 9.0 5.7 3.6
Govt EM IG HY
2015
1.7 0.9 0.1 -2.1
Govt IG EM HY
2014
8.7 8.0 7.9 2.7
HY IG Govt EM
2013
7.3 0.2 -0.2 -4.5
EM HY IG Govt
2012
22.1 18.7 10.9 4.6
GOVT IG EM HY
2011
6.3 5.1 4.6 2.9
EM HY IG Govt
2010
15.2 14.9 7.5 3.9
HY EM IG Govt
2009
59.7 35.7 16.1 1.2
Govt IG EM HY
2008
11.7 -3.4 -16.1 -27.0
Govt EM IG HY
2007
6.4 5.6 3.8 2.5
EM HY IG Govt
2006
12.1 10.2 3.3 2.8
EM Govt IG HY
2005
14.4 6.5 5.2 4.9
EM HY IG Govt
2004
16.2 14.7 8.7 8.0
EM HY IG Govt
2003
36.1 30.6 8.7 4.4
EM Govt IG HY
2002
13.8 10.7 10.7 1.6
IG Govt HY EM
2001
10.0 7.3 4.7 -0.6
EM Govt IG HY
2000
13.4 10.2 8.5 -6.2
EM HY IG Govt
1999
24.9 3.1 1.7 1.3
Govt IG HY EM
1998
13.0 10.8 5.0 -15.1
Investment Emerging High yield
KEY Govt Government IG EM HY
grade corporate market sovereign corporate
Note: 1994-1997 US IG and HY indices used.
Source: Newton, Merrill Lynch Indices Hedged into Sterling, 31 December 2017.
10Economics and interest rates
(expectations and forecasts for 2018)
ALCENTRA INSIGHT INVESTMENT MELLON CAPITAL
Growth: from 2.25% to 3% across EU, UK and Growth: from 2.3% (2017 forecast) to 1.9% (2018 Growth: 1.2% to 2.2% range across EU,
the US. forecast) across Europe, from 1.1% (2017 forecast) 0.3% to 1.3% range in the UK and 1.9%
to 1.3% (2018 forecast) in the UK, and 2.6% (2017 to 2.9% range in the US.
forecast) to 1.9% (2018 forecast) in the US.
Inflation: 1.5% across EU, 3.5% in the UK and Inflation: 1.4% in 2018 in the EU, Inflation: 1.6% across EU, 2.6% in the
2.5% in the US. 2.5% in the UK and around 2.4% in the US. UK and 2.4% in the US.
Official interest rates in the EU very unlikely Official interest rates in the UK and US likely to No change in UK and EU interest rates
to rise, but UK likely to rise with a rise also gradually rise during the next 12 months, while no expected, with rates likely to rise in the
expected in the US. change is expected in the EU. US over the next 12 months.
Keys to bond valuations include: Inflation and Keys to bond valuations include: Global growth is in Keys to bond valuations include: the
rate rises, with a possible ‘taper tantrum’ in a synchronised upswing. The US Federal Reserve is normalisation of central bank short-
the EU. likely to continue normalising monetary policy at a term interest rates, strong global
gradual pace, while the Bank of England will likely economic growth and associated
hike once in 2018 and the European Central Bank inflation and demand for yield in an
will continue to taper its QE programme. In the US environment where nearly every asset
and Europe, inflation risks have shifted to the class is trading at historically rich
upside, while UK markets are focusing on how levels will all be important.
quickly inflation will fall back from the peak.
NEWTON STANDISH
Growth: 1% to 2% range across EU, 1% to 2% Growth: 2.2% across EU, 1.5% in the UK and 2.5% in
range in the UK and 2% to 3% range in the US. the US.
Inflation: 1.5% across EU, 2.5% in the UK and Inflation: 1.5% across EU, 2.5% in the UK and 2.3%
2.5% in the US. in the US.
No change to official interest rates in the EU Official interest rates in the EU are not likely to
expected but a modest increase in UK rates is change, but two rate hikes expected in the UK and
anticipated with US rates also likely to rise up to four rate hikes are expected in the US.
over the next 12 months.
Keys to bond valuations include: Central bank Keys to bond valuations include: : Inflation must
activity – particularly with regard to the move along a trajectory that justifies Fed rate hikes
anticipated reduction of loose monetary in the second half of the year. Across the G4 central
policy and tightening. banks, policy remains quite accommodative.
Including the Fed, any policy shifts are not expected
to tighten financial conditions materially. While
bond valuations could shift over the coming year
across the major global rates markets, they will
most likely do so slowly and with lower volatility
than in the past, given the structural downtrend in
global inflation.
INTERNATIONAL EUROPEAN DEBT CAPITAL MARKETS VOLUME Q4 2017 TOP 15 INTERNATIONAL DCM VOLUME BY CURRENCY Q4 2017
800 1,400 700 1,000
900
700 1,200 600
800
600
1,000 500 700
500 600
800 400
Deals
Deals
$bn
500
$bn
400
600 300
400
300
400 200 300
200
200
200 100
100 100
0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
0 0 0
USD EUR GBP AUD JPY SGD SEK CHF CAD CNY NOK COP TRY HKD KZT
2013 2014 2015 2016 2017
Volume No. of Deals Volume No. of Deals
Source: Dealogic as at 31 December 2017. Source Dealogic as at 31 December 2017.
11
Setting the scene 11Fixed Income/Q1 2018
Winds of
change
I
nvestors may face a more selective fixed income
environment as markets move away from the prolonged
period of low interest rates and as the global market
support provided by central bank QE programmes is phased
out. Here, BNY Mellon investment boutique managers
assess the evolving landscape.
12 Winds of changeSovereign debt
With more than US$8trn in fixed income wouldn’t expect this to have a materially major developed central banks. That
assets still featuring negative yields, the negative impact on fixed income assets, will inevitably drive some short term
market reaction in 2018 to continued as long as the pace of normalisation volatility and create potential pockets
gradual policy normalisation across major is gradual and well signalled. Instead of opportunity across various advanced
markets will be a key factor to watch, we think it could lead to more efficient bond market yield curves” he adds. Han
according to fixed income specialist markets.” believes as longer-term foreign sovereign
Insight Investment. Central banks will yields are likely to rise, short duration
want any rise in yields, if it occurs, to be Standish portfolio manager Thant looks attractive.
gradual in order to reduce the risk of Han believes the diverging pace of
financial market disruption, managers say. normalisation across major markets Outside of the US and European bond
could also present potential investment markets, managers see opportunities
According to Insight Investment’s head opportunities. “The size and speed in other government debt markets,
of UK and global credit Peter Bentley: of how renormalisation will occur particularly those not ripe for an
“In 2018, investors may have to contend remain somewhat uncertain across the interest rate rise – like Australia. In the
with the most significant and sustained
rises in government bond yields since DEVELOPED MARKETS EMERGING MARKETS
the financial crisis. Central banks will
10-Year Govt. Bond Yields (%) 10-Year Govt. Bond Yields (%)
accelerate their normalisation of monetary Developed Markets 10-Year Govt. Bond Yields (%) Emerging Markets 10-Year Govt. Bond Yields (%)
policy and the threat of inflation could add UK Turkey
fuel to the fire.” USA
Mexico
11.35
Canada
Indeed, while the start of 2018 saw an India
Spain
unusually becalmed US Treasury bond Germany
China
2.41
market – with volatility at its lowest 2.41 2.04 1.56 0.42 Poland
0.04 Japan
level in more than 50 years1 – this soon
gave way to major market movements 3.29
as US Treasuries led a sell-off in global 3.88
government bonds.2 The move was partly
prompted by the Bank of Japan scaling 7.32
7.65
back its monthly purchases of 10-25
year dated bonds and wider concerns
about the likely speed and scale of US QE
Source: Bloomberg Data as of 31 December, 2017. Source: Bloomberg Data as of 31 December, 2017.
withdrawal.3 Source: ISSG, Bloomberg Data as of 31 December, 2017. Source: ISSG, Bloomberg Data as of 31 December, 2017.
Despite this, many global fixed income
investors remain cautiously optimistic on GLOBAL AND EMERGING FIXED INCOME TOTAL RETURN BY SELECT MARKETS (%)
sovereign bond prospects for 2018 – with 1 month 3 months YTD 1 year 3 years 5 years 7 years 10 years
some predicting normalisation could (%) (%) (%) (%) (%) (%) (%) (%)
eventually bring significant market and Global Aggregate (Unhedged) 0.35 1.08 7.39 7.39 2.02 0.79 1.97 3.09
investment benefits. While central banks Global Corporate (Unhedged) 0.80 1.44 9.09 9.09 3.13 2.57 4.02 4.26
Global High Yield (Unhedged) 0.46 0.87 10.43 10.43 7.08 5.67 7.18 8.08
will gradually step back from the market,
EM $USD Aggregate 0.39 0.62 8.17 8.17 6.38 3.87 6.22 7.01
some analysts point out that governments
look likely to increase borrowing from
private investors in 2018 for the first U.S. FIXED INCOME
time in four years, with an anticipated 1 month 3 months YTD 1 year 3 years 5 years 7 years 10 years
US$255bn debt offered for sale.4 (%) (%) (%) (%) (%) (%) (%) (%)
US Aggregate 0.46 0.39 3.54 3.54 2.24 2.10 3.20 4.01
Commenting on the likely impacts of US US Treasury 0.31 0.05 2.31 2.31 1.40 1.27 2.55 3.31
interest rate rises, Mellon Capital head US TIPS 1.01 1.41 3.30 3.30 2.10 0.17 3.04 3.60
of fixed income Paul Benson says: “The US Agencies 0.11 0.06 2.98 2.98 1.62 1.37 2.10 3.00
QE efforts have caused a tremendous US Municipals 1.05 0.75 5.45 5.45 2.98 3.02 4.62 4.46
US Securitised 0.32 0.16 2.51 2.51 1.92 2.04 2.77 3.81
amount of dislocation in the market. This
US IG Corporates 0.91 1.17 6.42 6.42 3.90 3.48 5.02 5.65
means normalisation is probably a good
US High Yield 0.30 0.47 7.50 7.50 6.35 5.78 7.04 8.03
thing overall. While interest rates could
US Leveraged Loans 0.40 1.11 4.12 4.12 4.44 4.03 4.45 4.85
rise with the normalisation of QE we
Source: ISSG, Barclays Capital, Bloomberg and S&P. Data as of 31 December 2017. Returns for periods greater than one year are
annualised. Investments involve risks. Past performance is not a guide to future performance.
1 FT. Warning signs emerge for the US Treasury market. 08 January 2018.
2 FT. US Treasuries lead bond sell off as BOJ trims buying of long-dated debt. 10 January 2018.
3 FT. QE withdrawal sparks bond sell-off. 11 January 2018.
4 FT/JPMorgan Chase analysis. Pick-up in borrowing to test low-yield era. 18 January 2018. Winds of change 13Fixed Income/Q1 2018
fourth quarter of 2017 Newton’s fixed Emerging market debt
income team leader Paul Brain favoured
Record net inflows of just under US$69bn US rates have materially repriced over the
Malaysian and Russian government
last year5 helped drive a strong emerging last 12 months,” he says.
bonds as well as longer-dated sovereigns
market bond rally in 2017 in what proved
in peripheral Europe. Insight’s head of emerging market
to be a year of strong returns. Geopolitical
flare-ups in emerging markets such as debt Colm McDonagh agrees on US
Han says he sees some value in certain
Venezuela and Argentina failed to dent rate movements and also points to the
peripheral European government bond
investor optimism on EM fixed income, potential benefit of stabilising commodity
issuers. Portugal, for instance, has
with local currency debt delivering its prices. “We continue to think the outlook
benefited from its upgrade to investment
strongest returns since 20126 against a for the asset class is positive. We expect
grade by Standard & Poor’s and Fitch, as
broadly favourable policy backdrop. commodity prices will continue to be
reported by Reuters in December, taking
better behaved on the back of more
the sovereign issuer once again to sit
According to some estimates, EM debt balanced supply and demand dynamics
alongside its European government bond
hard currency funds could hold over in oil,” he adds.
peers in major benchmarks such as the
US$1trn in assets by the end of 20187
Bloomberg Barclays indices. This, Han Garcia Zamora adds that despite the
with local currency denominated bonds
says, should support further investor risk a rising US rate environment poses,
(EMDLC) expected to continue recent
demand for its bonds. he believes the other important global
popularity with inflows set to overtake
dollar denominated inflows. macroeconomic drivers of emerging
markets growth remain stable. “China
But: After a rebound in the EMDLC sector in continues to temper its economic growth
Newton’s Brain believes 2018 will be late 2017, Standish managing director, trajectory in a deliberate manner and
a year of mixed fortunes for global head of emerging markets debt Federico commodity and oil prices remain fairly
bond markets, holding both threats Garcia Zamora believes the asset class stable. Emerging markets are experiencing
and opportunities against a shifting continues to hold potential. a low global inflationary environment, a
economic backdrop. cyclical upturn in global gross domestic
“Looking at the big picture the product growth and a positive risk
“This year is likely to be one of environment for EMDLC looks bright. The appetite from investors who are looking
transition for bonds, warranting a external forces that drive the asset class for alternatives to low core rates.”
cautious level of interest rate risk – global interest rates, commodities, and
initially while the central banks get US dollar levels – are materially more With respect to EM corporates McDonagh
into their tightening stride. However, supportive than a couple of years ago.” believes the primary market should
at some point in 2018, we would continue to perform well in the face of
expect risk assets to wake up to Garcia Zamora believes valuations in higher US Treasury yields, as long as the
this tightening phase and re-price – EMDLC issues look attractive and the move higher is driven by stronger growth
prompting demand for safe-haven outlook for the asset class is positive given expectations rather than a hawkish shift
assets such as government bonds,” Standish’s stance that the bulk of the re- in regime. “We believe a continuation
he says. pricing of US rates is behind us. “The Fed is of the current benign environment and
now well advanced in its hiking cycle and low levels of default should keep market
In the near term, Brain notes:
“In Europe, low yields and growth
momentum render German Bunds
unattractive, while the recurrence of But:
political risks (including the fall-out Geopolitical uncertainty in some major range of valuations. “This divergence,
from Catalonia’s referendum and emerging markets such as Mexico combined with political risks, both at
imminent Italian elections) is likely and Turkey remains an issue. Recent a domestic level in certain countries
to continue to impede ‘peripheral’ inflows to the EM sector have also and emanating from broader global
sovereign spread compression. In raised asset prices to the point where risks, will make a flexible approach to
the UK, deeply negative real yields some managers say investors are investment an important factor in 2018.”
warrant a cautious approach to reconsidering further investment.
As for corporate debt McDonagh
Gilts, while ongoing Bank of Japan
Insight Investment’s McDonagh notes says in the short term valuations
purchases should keep Japanese
regional and market divergence within warrant greater selectivity and a
government bond yields relatively
emerging market assets is high, with cautious approach to the asset class,
stable.”
headline index values encompassing a particularly in the secondary market.
5 Source: Morgan Stanley/EPFR. FT. Charts that matter: EM debt funds see record net inflows. 09 January 2018.
6 Bloomberg. Emerging Markets Shrug Off Crises For Best Gains in Eight Years. 12 December 2017.
14 Winds of change 7 Reuters. JP Morgan sees 7-8 pct gain for EM debt in 2018, but road could be bumpy. 22 November 2017.EMERGING MARKET DEBT
1 month 3 months 1 year 1 year 3 years 5 years 7 years 10 years
(%) (%) (%) (%) (%) (%) (%) (%) Duration
EM $USD Aggregate 0.39 0.62 8.17 8.17 6.38 3.87 6.22 7.01 5.86
EM Sovereign (Unhedged) 0.57 0.69 9.29 9.29 6.64 4.09 6.62 7.24 7.22
EM Corporate (Unhedged) 0.37 0.86 7.99 7.99 6.01 3.98 5.45 6.84 4.71
EM Local Currency (Unhedged) 1.45 2.17 14.27 14.27 2.73 0.35 2.33 2.33 5.59
20 6.0%
18
5.0%
16
Yield to worst (%)
14 4.0%
Spreads (%)
12 3.0% 2.55%
2.26% 2.34%
10
2.0%
8
6 Dec ’17 4.90% 1.0% 0.52%
Dec ’17 4.87%
Dec ’17 4.51%
4 Dec ’17 4.50% 0.0%
04 05 06 07 08 09 10 11 12 13 14 15 16 17 EM EM EM Corp EM
Aggregate Sov Sov
EM aggregate (USD) EM Sovereign (USD)
(USD) (USD) (Local)
EM corp EM Sovereign (Local)
Source: ISSG, Barclays Capital and Bloomberg.
Data as of 31 December 2017. Returns for periods greater than one year are annualised.
sentiment supportive. Technicals should
remain strong into 2018, we believe, with
inflows sustained by this positive investor
sentiment and net issuance remaining
Nevertheless, 2018 has already brought
positive news for some other currencies.
January saw sterling hit its highest level
since the 2016 Brexit referendum on
“ We believe a continuation
of the current benign
manageable.” better than expected employment figures
environment and low
and a weak dollar.
According to Insight Investment the next levels of default should
few years could be a major opportunity According to Newton’s Brain, upside for keep market sentiment
the US dollar may be limited in 2018, with
for emerging markets, which are generally supportive.
Fed interest rates close to their peak. He
more sensitive to the global economic
believes other central banks may follow
cycle due to exposure to exports and
in raising rates but also feels a weaker Colm McDonagh, Insight
commodity prices. McDonagh notes
dollar can bring some benefits to wider
yields in EMD still look attractive relative some renewed optimism to currency
currency and fixed income markets.
to developed markets, both for local markets. “The global growth-outlook
government debt and corporate debt “A softer dollar can prolong the global remains extremely positive and this is
issued in hard currencies. liquidity story and, with it, global growth. supportive for growth sensitive currencies
In the absence of political risk, currencies including emerging market currencies.
Currency with high current account surpluses will Some growth-sensitive currencies have
While US stock markets have been tend to rise against those with deficits. recently performed well in this positive
buoyant under the Trump administration, This puts the euro and possibly the yen environment. In emerging market
in the driving seat. In addition, emerging currencies the South African rand has
the dollar has fared less well. The opening
market currencies can catch a bid been among the biggest gainers,” he says.
trading day of 2018 saw the US currency
while global growth remains strong and
drop to its lowest level in three months “At a broader market level, we think that
synchronised,” he says.
on concerns over Fed interest rate policy, ultimately the growth dynamic should
extending a 2017 decline which had seen According to Insight Investment’s head dominate, particularly if inflation in the
the dollar post its weakest performance of currency Paul Lambert, a healthy US remains low and the Fed continues
in 14 years.8 economic growth outlook is also bringing to tighten at a cautious pace.”
8 Reuters. Dollar slides to more than three-month low on first trading day of 2018. 2 January 2018. Winds of change 15Fixed Income/Q1 2018
Insight Investment’s managers note US and Europe should be sufficiently
But: some of the broader trends occurring positive to support earnings momentum
Against a backdrop of central bank in the high yield end of the market: this year, keeping defaults in check.
change and ongoing global political “The number of rising stars (those European (ex UK) credit fundamentals
uncertainty even some of the most issuers upgrading from high yield to remain solid, helped by an improving
upbeat currency investors are braced investment grade) is now higher than economy and decent earnings growth,”
for further bouts of uncertainty in the the number of fallen angels (those he says. “Despite significant tightening
year ahead. downgraded to high yield) for the first in yields and credit spreads, we think
time since 2014.” (see page 22). the European high yield sector still
According to Newton’s Brain: “The looks relatively attractive from an
outlook for currencies may become This is notable in the energy sector where
income perspective (even in a rising
more challenging during the second those companies that have controlled
rate environment).”
half of the year, should tighter Fed costs and paid down debt have since
policy eventually dampen economic benefited. “For example, one of the While some comment valuations in high
activity and render ‘safe-haven’ world’s largest mining companies was yield looked rich as at the beginning of
bonds increasingly attractive.” faced with a credit rating downgrade in 2018, Gerhard says the technical picture
2016, only to be upgraded once again remains supportive, with limited net
Ongoing market volatility remains an in 2017. If the momentum in the global new issuance.
issue. January saw notable intraday economy continues into 2018, then this
forex shifts hit both the Mexican powerful technical dynamic within the “We do not envisage European interest
peso and the Canadian dollar – high yield market should continue.” rates moving significantly higher
following unsubstantiated rumours during 2018 and expect this to happen
US president Trump was about to Assessing fundamentals within the
sometime in 2019. We anticipate some
renew plans to remove the US from asset class, Insight portfolio manager
short-term market weakness, largely
the Nafta free trade agreement. Ulrich Gerhard says he believes the sub-
due to political issues surrounding
investment grade market will continue to
Catalan independence, the Italian
The episode highlighted the Trump attract yield-hungry investors this year,
elections and Brexit. However, we think
administration’s market influence with short-dated issuance of particular
a less favourable supply/demand
and ability to rattle global currency appeal. He notes most high yield paper
outlook could present some buying
markets.9 In the UK, rolling news can be refinanced early via call options,
opportunities. Therefore, we continue to
coverage of the latest ‘Brexit’ with about 70% of these bonds called
look for opportunities, particularly in the
developments also continues to within one to two years of their call date,
stoke volatility. US, the UK and emerging markets. With
making them attractive to many investors.
idiosyncratic risks growing, we believe
Commenting on the wider high yield bottom-up credit analysis will be even
market outlook, he says: “In our view the more important during 2018,” he adds.
High yield
After a largely positive 12 months,
January 2018 saw the US high yield bond
But:
While the high yield sector saw some potential influence US leverage levels
market enjoy its strongest start in four
record breaking numbers in 2017, the and wider macroeconomic factors
years, with sales more than tripling levels
end of the year also saw significant might have on the sector.
seen at the same point in 2017.10
signs of shrinkage in the European high
“The associated political uncertainty
Memories of the post-2016 price collapse yield corporate bond space.
Brexit has brought about in the UK and
in high yield US energy sector bonds also Against a backdrop of companies EU poses a significant challenge. There
now appear to be fading. gaining or regaining stronger credit is additional concern about how the
ratings, a wave of corporate buybacks high yield market would deal with any
Looking ahead, growing merger and
and exits from the sector, credit ratings significant investor outflows, given poor
acquisition (M&A) activity is expected
specialist Fitch Ratings warned of secondary-market liquidity,” he adds.
to help galvanise European high yield
“increasing uncertainty” and rising risk
issuance throughout 2018. Managers also comment that although
in the market.11
high yield has been supported by
“On the high yield front we are encouraged Despite a generally favourable short- low supply and high investor cash
by the stabilisation in commodity and term outlook on high yield, amid solid balances, credit yield spreads now
energy prices and to some extent that growth and elevated corporate profits, appear to be at the more expensive end
should be very supportive for corporate Newton portfolio manager Parmeshwar of the range.
issues exposed to that particular sector,” Chadha is also concerned by the
says Standish’s Han.
9 FT. Markets wary of revival in Trump trade protectionism. 12 January 2018.
10 FT. Junk bond sales triple as investor optimism soars. 12 January 2018.
11 FT. Fitch warns of rising risks for European high-yield bond market. 08 November 2017.
16 Winds of changeUS HIGH YIELD & LEVERAGED LOANS
1 month 3 months YTD 1 year 3 years 5 years 7 years 10 years
(%) (%) (%) (%) (%) (%) (%) (%) Duration
US High Yield 0.30 0.47 7.50 7.50 6.35 5.78 7.04 8.03 3.75
High Yield (BB) 0.10 0.39 7.32 7.32 6.21 5.81 7.17 8.40 4.39
High Yield (B-CCC) 0.47 0.35 7.24 7.24 6.09 5.43 6.83 7.44 3.46
Leveraged Loans 0.40 1.11 4.12 4.12 4.44 4.03 4.45 4.85 ~~
30 10
25
8
20
Yield to worst (%)
Spreads (%)
6
15 4.41%
4
10
2.11%
Dec ’17 6.71%
5 2
Dec ’17 4.37%
0 0
04 05 06 07 08 09 10 11 12 13 14 15 16 US HY BB US HY B-CCC
BB B-CCC
Source: ISSG, Barclays Capital and Bloomberg. Data as of 31 December 2017. Returns for periods greater than one year are annualised. Investments involve risks.
Investment grade numbers. Broadly speaking, it is hard markets as long as moves remain orderly
for us to see any imminent catalyst that and contained.”
Over the past decade, the investment
could hurt the corporate bond market and
grade corporate debt sector has However, the effect of the reduction in
we see very few signs that defaults will
managed to shake off a range of support of global central bank asset
pick up in the near future.”
challenges including commodity price purchases is uncertain and could be a
slumps and more general spread Peter Bentley, head of UK and global threat, he notes, adding 2018 will likely
tightening. Last year alone saw inflows credit at Insight Investment believes be a trickier year for credit investors
of more than US$277bn to global corporate default rates will likely be than 2017.
investment grade bond funds.12 around record lows and the global
growth picture should also be positive Within Europe, Insight credit manager
The comparatively attractive returns
for corporate earnings. “Furthermore, Lucy Speake says economic data
on offer from investment grade paper
the potential for rising government continues to be very strong, in some
continue to attract a wide range of global
bond yields is unlikely to threaten credit cases at multi-decade highs. “Headline
investors to a market which has seen no
shortage of supply. Last December saw
US investment grade bond issuance hit EURO-DENOMINATED CORPORATE INVESTMENT GRADE VOLUME Q4 2017
US$1.276 trillion – in moves which broke
annual issuance records for the sixth year
140 180
in a row.13
120 160
In the US, the Trump administration’s 140
100
efforts to reform tax and boost economic 120
growth have been welcomed by many 80 100
Deals
$bn
investors in corporate debt who feel
60 80
his policies should ultimately boost the
60
fortunes of issuers. 40
40
Mellon Capital’s Benson says: “A lot of 20 20
companies in the corporate debt space
0 0
will likely benefit from the Trump tax Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
reforms and could see better top line 13 13 13 13 14 14 14 14 15 15 15 15 16 16 16 16 17 17 17 17
growth and produce higher revenue Volume Number of deals
Source: Dealogic as at 31 December 2017.
12 FT. Hidden gyrations underpin global flows. 29 December 2017.
13 International Financing Review data/Reuters. U.S. corporate bond issuance breaks records for sixth year. 06 December 2017.
Winds of change 17Fixed Income/Q1 2018
inflation has broadly stabilised while core Inflation-linked bonds premium to protect oneself from any
inflation is only increasing very gradually; upside surprises to inflation over the
Following the global financial crisis, a
however, risks have shifted to the upside,” medium term is an attractive proposition
benign inflationary environment had
Speake adds. to consider,” he says.
helped dampen investor appetite for
“
The ECB is moving to reduce its QE inflation-linked bonds. But renewed
purchases from January 2018 and inflationary pressures across some major
could stop altogether next September markets have once again driven fresh
if the economy remains strong, she interest in these securities. Upward pressure
notes. Similarly, the removal of negative
While US investors wait patiently for on Gilts is likely to
deposit rates is likely to occur in the first
three quarters of 2019. “However, in the
inflation to pick up, others view a different increase this year,
meantime, corporate bond purchases are
picture. In the UK a falling pound – that with opportunities
followed the 2016 Brexit referendum
likely to continue at a high level within the
result – initially stoked concerns about
remaining in US TIPS
programme. Overall, our view is that euro
rising inflation throughout 2017. at the long-end.
credit continues to be well supported.”
UK inflation rose to 3.1% in November
David Hooker, Insight
2017, the highest level in nearly six years.15
But: In turn, November also saw the British
After several years of record issuance debt office generate record demand for Mellon Capital’s Benson reports a
and strong demand, some portfolio the sale via syndication of a £3bn sale of benign inflation picture in the US but
managers believe the US investment 2048 index-linked gilts – receiving orders similarly believes inflationary pressures
grade market cycle is nearing its end. worth £23.7bn,16 with the new Gilts eight could soon pique interest in Treasury
Spread tightening and the narrowing times oversubscribed. Inflation-Protected Securities (TIPS). “US
yield gap between risk free US inflation expectations have been ticking
Treasuries and corporate bonds have At Standish, Han monitors the global up gradually from the market side but
led some analysts to believe a bull inflation picture closely and anticipates we are not seeing any dramatic changes
run in investment grade debt is over.14 rising interest in inflation-linked bonds in inflation yet. That doesn’t mean
in 2018. “While inflation is likely to investors shouldn’t be wary of future
Insight’s Wickham believes the remain modest in Europe compared inflation. As such, TIPS could be a good
gradual winding down of central bank to other inflation rates across the way of addressing concerns about higher
QE programmes could negatively developed world, we do think the current inflation,” he says.
impact the corporate debt sector.
“Investment grade credit spreads
have continued to tighten although
default rates remain very low. We But:
think investment grade credit is now While inflation-linked bonds can offer strong benefits when market conditions are
pretty fully valued and winding back supportive, these assets often have a longer duration than conventional bonds,
of QE could be a fresh headwind making them potentially more vulnerable to sudden interest rate rises.
for the asset class,” he says. Jesse
Across major markets the inflationary picture also remains more unpredictable
Fogarty, senior portfolio manager
than some forecasts suggest – with the UK rate actually falling back in January.17
at Insight, adds investors need
to be cautious given historically Looking ahead, ECB tapering may also impact some European ‘linkers’.
tight valuations with respect to US Commenting on this, Insight’s Hooker predicts upward pressure on Gilts is likely to
investment grade debt. Stock and increase this year, with opportunities remaining in US TIPS at the long-end.
sector selection will be key, he notes.
Managers at Insight also note the Bank of England expects the effects of rising
Commenting on the outlook for import prices on inflation to dissipate in 2018 but for domestic inflationary
Sterling denominated investment pressures to gradually increase, partially due to a recovery in wage growth. They
grade assets Newton’s Brain also add that in 2018, wage growth and the strength of the labour market will be critical
sounds a note of caution. “We to perceptions about longer-term inflation rates and thus future UK monetary
believe tight spreads and the policy. Given this backdrop, inflation may prove to be more resilient than expected,
unattractiveness of Gilts justify even if economic growth slows.
cautious duration positioning in
sterling-based investment grade
credit at this time,” he adds.
14 Barrons. Warning signs for corporate bonds. 14 January 2017.
15 BBC News. UK inflation rate at near six-year high. 12 December 2017.
16 Reuters. UK draws record demand for 2048 linker syndication sale. 07 November 2017.
17 BBC News. UK inflation rate drops back to 3%. 16 January 2018.
18 Winds of changeYou can also read
