London, 24 June 2021 —  Russell Investments’ latest quarterly survey of fixed income managers found about 70% of respondents expect inflation for the next 12 months to exceed 2%, surging from 38% who expressed that view in the Q1 survey. The 72 bond and currency managers who responded to the Q2 2021 survey also expressed less confidence that the U.S. Federal Reserve (Fed) will deliver its target inflation rate. About 50% expect the Fed to deliver its inflation promise, declining about 10 percentage points from the previous survey.

“Fixed income managers expect higher inflation to continue a little longer as the transition from lockdowns to full economic recovery accelerates,” said Adam Smears, Head of Fixed Income Research at Russell Investments. “With higher inflation on their radar and the prospect for interest rate hikes moving forward, we expect managers will be digging deeper into asset classes in their hunt for yield.”

The survey found 31% of fixed income managers expect the Fed to start tapering its asset purchase programme as soon as in Q4 2021, though, the consensus expects the most likely timing to be Q1 2022. Respondents also believe interest rates will remain lower for longer. About 80% expect the next Fed hike will not occur before 2023, increasing from 36% in the Q1 2021 survey. After lift-off, 80% of managers expect between two to four interest rate hikes per year.

The survey also revealed less consensus around movement of the U.S. yield curve, with 43% of managers expecting a bear steepening of the yield curve in the next 12 months (versus 71% in the Q1 2021 survey.) In addition, 86% of respondents expect the 10-year U.S. Treasury yield to trade between 2.0% and 3.0% in the next 12 months, including 45% of managers who pin it between 2.5% and 2.75%.

The Q2 survey also assessed sentiment among fixed income managers for investment-grade (IG) credit, leveraged credit, emerging markets, currencies and securitised sectors.

• Investment-grade credit: Almost 30% of respondents expect a moderate widening in spreads in the next 12 months (up from just 5% in Q1 2021), versus 60% predicting range-bound spreads. Overall, respondents expect spreads to widen by 5 basis points (bps), revealing a change in sentiment from the Q1 2021 survey when managers expected a spread compression of -6 bps. Meanwhile, 70% of managers remain confident on declining leverage of IG companies whilst almost 30% of managers expect leverage to remain at least stable over the next year. When considering potential material mispricing, managers pointed to the energy and utilities sectors given increasing investor focus on environmental, social and governance (ESG) issues.
• Leveraged credit: 83% of managers expect range-bound spreads over the next 12 months versus 50% in the Q1 survey, while only 9% of respondents still expect a moderate tightening. In addition, 70% expect to see a material improvement in corporate fundamentals, an increase of 5% compared to the previous survey. Respondents see U.S. leveraged loans as offering the most compelling market opportunities, followed by CLO Mezzanine. Reflecting on the most concerning potential risks for the global high yield market in the next 12 months, managers selected inflation and rising interest rates. No manager expressed concerns about inflation in our Q1 2021 survey. In addition, almost 80% of managers expect defaults to be between 0-3% in the next 12 months, compared to 50% of respondents in the Q1 survey who saw defaults in the 3-5% range.
• Emerging markets (EM) : Survey respondents remain very constructive on EM currencies, with almost 86% expecting positive performance from developing currencies in the next 12 months. Roughly 17% of managers expect EM FX to post strong positive returns over the period, dropping from 40% in the Q1 survey, while 11% expect FX to be a detractor. Looking at EM FX opportunities, managers expect the Brazilian real and the Russian ruble to outperform in the next 12 months, while 35% expect Turkish lira to be the worst-performing EM currency, in stark contrast to the previous survey where the Turkish lira was the top overweight trade. Overall, 63% of managers expect positive FX returns in the next 12 months, including 10% who see rates as offering the most positive return potential.

Managers are however less bullish on hard currency emerging market debt (HC EMD). Only 33% expect spreads in the benchmark to tighten in the next 12 months, dropping from 74% in the Q1 survey. They expect a weighted-average return at 3.9% over the next 12 months. From a country preference perspective, managers selected Ukraine and Egypt as offering the highest expected return over the next 12 months. China and the Philippines remain as the top two underweight countries. In addition, managers picked Fed policy, followed by changes in the level of U.S. Treasuries, as the top two most significant risk factors for hard currency EMD performance in the next 12 months.

• Currency: Expectations for the Euro are wider, with 80% of managers expecting the Euro to trade in the 1.21-1.30 range. In our previous survey, 61% of managers expected the euro to be in the 1.21-1.25 range. Managers expressed more consensus with a tilt towards appreciation of the British pound with 72% of respondents expecting the British pound to be in the 1.41-1.50 range in the next 12 months. In our Q1 survey, 77% of managers expected the British pound to be in the 1.36-1.50 range. 61% of managers expect EM FX implied volatility to increase in the next 12 months. 65% expect implied volatility in G10 countries to increase.
• Securitised sectors: Managers expressed more conservative views in the securitised segment. Only 19% plan to add risks in their return-oriented securitised portfolios in the next 12 months, dropping from 50% in the Q1 survey, while 67% expect to maintain current risk levels. When asked about taking a meaningful beta position, 22% noted that they already have a long basis in their portfolios, down from 64% in the Q1 survey, while 50% expect to add short positions. The survey also found 48% of managers expect non-agency spreads to moderately tighten in the next 12 months, declining from 57% in the Q1 survey, while 29% expect spreads to be range bound. Regarding long/short positions on CMBX.6.BBB-, 47% of managers responded they would take a short position, while 32% responded that they would buy protection. As for the CLO market, managers expressed more balanced views with 57% mentioning broad risk-off market sentiment as the main risk, followed by underlying loan collateral credit deterioration.

About Russell Investments

Russell Investments is a leading global investment solutions firm with £236.9 billion in assets under management (as of 31/03/2021) for clients in 32 countries. The firm provides a wide range of investment capabilities to institutional investors, financial intermediaries and individual investors around the world. Building on an 85-year legacy of continuous innovation to deliver exceptional value to clients, Russell Investments works every day to improve people’s financial security. Headquartered in Seattle, Washington, Russell Investments has offices in 19 cities around the world, including in New York, London, Tokyo, and Shanghai. For more information, please visit www.russellinvestments.com.

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First used: June 2021