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Fixed Income Strategic Forum

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Higher rates, tighter credit, and less liquidity matter

Maybe it’s different this time?

We believe contributors to market resilience, including fiscal support, artificial intelligence (AI)-led equities, and quantitative easing (QE), seem poised to fade, as does "maybe it’ll be different."

Brace for impact

The long and variable lags of significant monetary, credit, and liquidity tightening are converging. It’s only a matter of time.

QT – the straw that broke the (bond) market's back?

With the US Federal Reserve implementing quantitative tightening (QT) again, bond markets are asking "who will buy bonds now?" The market is disconnecting from fundamentals.

Higher for longer? Well, until something breaks

"Higher for longer," in such an indebted system, is not celebratory. The longer rates stay higher, the more inevitable financial market dislocation.

Fixed Income Strategic Forum podcast

Higher rates matter. Tightening of credit conditions matters. QT matters."

Brett Lewthwaite
CIO and Head of Fixed Income

Asset class viewpoints and our strategy

  • A volatile (but delayed) risk environment for markets is expected, necessitating a prudent investment approach.
  • Our focus remains on defensive investment positioning, watchful for shifts in liquidity that could suddenly arise.
  • History guides that bond yields decline once the hiking cycle has clearly peaked, and thus we remain positive on bonds.
  • Global credit markets have been resilient, but we maintain a cautious outlook as valuations are pricing limited downside scenarios.
  • Central banks are likely near the end of their hiking cycles, though remain highly “data dependent” as to the path ahead.
  • While further rate hikes may be possible should resilience in key data (e.g. in US labour markets) remain, the restrictive nature of tightening to date combined with a consistent decline in inflation suggests bond valuations are attractive and are supportive of elevated duration exposure.
  • We favour the front-end of curves, where yields are relatively insulated from bond supply and demand-related concerns, as we approach the end of the cycle.
  • Credit spreads do not reflect the heightened volatility backdrop for markets and the uncertain economic outlook, and as such we remain cautious on the broad sector.
  • We believe the lagged effect of significant tightening will impact the broader economy, leading to earnings and ratings pressure. 
  • Our outlook for credit remains defensive, however, nuances across markets are providing individual opportunities to add value. We expect to add to credit exposures at more attractive levels.
  • The global backdrop continues to be the main driver for the asset class, with spreads on hard currency debt remaining stable compared with same-rated global credit.
  • Corporates with proactive balance sheet management, and reform-minded sovereigns with buffers are favoured, although valuations remain tight
  • We maintain a neutral view on the asset sector and look to increase exposure as valuations/environment improve.
  • Fundamentals bottomed in the wake of the historic tightening of the monetary policy, however, we believe a sustainable recovery is underway in US housing. 
  • We see opportunities in mortgage-backed securities (MBS), especially US agency-backed MBS, which we feel are offering attractive spreads backed by robust structures and stronger credit fundamentals. 
  • Commercial MBS spreads remain at historical wides, though face challenged fundamentals.
  • USD – The US dollar has been caught in a range unlikely to be resolved in the near term, though our medium-term view is for structural weakness to present.
  • EUR – Widening EU-US yield differentials and weakening external sentiment are likely to weigh on valuation of the euro.
  • AUD – Decoupling from global equity markets has occurred, and further weakness in the Australian dollar is expected while Chinese economic weakness persists.
  • JPY – Yield curve control adjustments have impacted the Japanese Yen, though a broader shift of monetary policy is required to halt the decline. 

Previous Fixed Income Strategic Forum insights

One of the challenges with investment management is balancing the short-term noise of financial markets with a longer-term assessment of the investment and economic landscape. The Fixed Income Strategic Forum is held three times a year, comprising more than 130 investment professionals, and operates to establish our medium-term views and strategic portfolio positions. Check out our previous Strategic Forum insights below.

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The views expressed represent the investment team’s assessment of the market environment as of 2023, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

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Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

Diversification may not protect against market risk.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt. This includes prepayment risk, the risk that the principal of a bond that is held by a portfolio will be prepaid prior to maturity at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.

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Currency risk is the risk that fluctuations in exchange rates between the US dollar and foreign currencies and between various foreign currencies may cause the value of an investment to decline. The market for some (or all) currencies may from time to time have low trading volume and become illiquid, which may prevent an investment from effecting positions or from promptly liquidating unfavourable positions in such markets, thus subjecting the investment to substantial losses.

Credit risk is the risk of loss of principal or loss of a financial reward stemming from a borrower’s failure to repay a loan or otherwise meet a contractual obligation. Credit risk arises whenever a borrower expects to use future cash flows to pay a current debt. Investors are compensated for assuming credit risk by way of interest payments from the borrower or issuer of a debt obligation. Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk.

Liquidity risk is the possibility that securities cannot be readily sold within seven days at approximately the price at which a fund has valued them.

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Inflation is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.

Quantitative easing (QE) is a form of monetary policy in which a central bank, like the US Federal Reserve, purchases securities from the open market to reduce interest rates and increase the money supply.

Quantitative tightening (QT) refers to when central banks raise the federal funds rate. In a tightening monetary policy environment, a reduction in the money supply is a factor that can significantly help to slow or keep the domestic currency from inflation.

Recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

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