End-year Fixed Income Survey 2019: The Federal Reserve shifts to a "mid-cycle adjustment" approach - are markets on the same wave-length?

Throughout the year we asked leading bond and currency managers to consider valuations, expectations and outlooks for the coming months.

In this latest survey, we asked 52 managers for their feedback. Interest rate managers absorbed three interest rate cuts since our last survey (including the recently announced cut on October 30) and now expect another cut to come, broadly in line with what the market is currently pricing. Meanwhile, credit managers are tilting towards being more cautious and shifting fears of a global slowdown to a potential US recession.

On one hand, we have a Federal Reserve (Fed) looking to make precautionary adjustments and on the other we have credit managers now fearing that perhaps those adjustments aren’t enough. There is also an expectation of a modest widening in credit spreads. That is why in this survey we explore: are markets on the same page as the Fed on its mid-cycle adjustment approach?

Mid-cycle adjustment?

Over the course of the year, we experienced the ramifications of a complex trade war between the US and China, Brexit uncertainties and moderating global economic data – notably with weakening manufacturing PMIs. However, inflation has remained relatively steady. This backdrop became the battle field with which developed central banks had to contend with.

The Fed is trying to address this backdrop by employing a mid-cycle adjustment approach, which uses precautionary interest rate cuts to ensure the safety and soundness of the nation’s markets. Recall that the historical threshold of the mid-cycle adjustment during the last cycles (1995/1998) was of 75 basis points, and with the latest cut of 25 bps during October, this limit has now been reached.

How concerned are markets?

Views from interest rate managers

  • As expected by most of the managers, the Fed cut the reference rate in 25bps during the last meeting of the FOMC of October. As for this, the expectation of managers going forward if for another cut in the next 12 months. Not one manager expects a hike in the next 12 months and only a small fraction of managers expects there to be a hike in the 12 months beyond that.
  • Meanwhile, 70% of managers also believe that we have seen the peak in the Fed Funds Rate this cycle.
  • They also indicated modest to no real concerns about inflation for the next 12-months.
  • 68% of managers further increased their conviction in the steepening of the yield curve. It was only a year ago that 59% of managers expected a flatter yield curve. A steeper curve makes sense given their range bound expectations for the US 10-year Treasury yield, and expectations for another cut in the next 12 months (with the most recent cut on October 30 further steepening the curve, as predicted by a majority of managers).

Views from credit managers

  • Within the Global Leveraged Credit space, managers shifted their outlook for spreads in the next 12 months from range bound in Q2 to a moderate widening of 10 to 30 bps in Q3. Most also believed business fundamentals were modestly deteriorating – the most since the survey started (Q3 68% vs Q2 12%). They also added that a US recession, rather than a slowdown in global growth, was their biggest fear.
  • In the Global IG Credit segment, managers also expect widening credit spreads, but on a more moderate scale. It is worth noting that 58% managers also thought that credit spreads do not compensate you for risks – the highest yet for the survey. However, 40% of managers additionally thought that leverage of BBB rated companies in the index will decrease – which is also the most since the survey started. With BBBs becoming such a substantial percentage of Investment Grade indices, the trajectory of fundamentals is topical at the moment.
  • There was a modestly bullish tone when it came to securitized assets, with managers adding a bit more risk than in the last quarter. Credit Risk Transfer remains the most favoured sector, but BBB CLOs have jumped up materially. Managers also preferred to be long CMBS.

Risk across the globe

Europe and UK

  • Since the last survey, managers continued to be less optimistic on Europe (including the UK). In Credit, Europe had previously been more popular, but the US has maintained its lead in both corporate high yield and investment-grade credit.
  • FX managers have also retained a weakened view on the euro - expressing concerns about the recovery of the European economy.
  • For the British pound, the view from FX managers is that Brexit uncertainty remains the driver for the currency, but with a lower probability of a hard Brexit, optimism returned with the sterling trading close to £1.295.

Emerging markets and Japan

  • More than half of hard currency EMD managers expect spread tightening, whilst a large majority of those expect it to be modest. Ukraine is now the most favoured country, with the Philippines remaining the least favourite. The biggest shift however was in Argentina, with almost 40% overweight preference in Q1 to only a mere 6% in Q3.
  • Local currency EMD rates continue to be viewed as cheap, despite all-time lows in the GBI-EM Local Currency Index yield. This is largely driven by expectations for lower inflation. The managers’ weighted total return expectations dropped down to 5.3% - the lowest since the survey started - likely accounting for the lowest yield recorded in the index.
  • FX managers remain neutral on the Japanese Yen compared to the previous survey – holding the currency as either a value or risk-averse position.


From this survey, credit managers are showing some signs of caution and may not be fully convinced by the trajectory of the Fed’s accommodative stance. We believe they understand that with tight spreads, future performance is predicated on the Fed being accommodative. Could this be challenged if the survey’s lack of concern around inflation proves to be incorrect? Whilst inflation expectations are muted, factors such as momentum in wage inflation, could push inflation higher - which may place the Fed in a more challenging situation with structural pressures to keep the dovish tone. With very little room for error, we find it interesting that although the interest rate managers are sold on an accommodative Fed, credit managers are exhibiting some vigilance.