Quarterly Fixed Income Survey: bound in a narrow range
After an 80 basis point jump in US Treasury yields following the US presidential election, fixed income money managers have adjusted to the new environment. Across rates, spreads and major currencies, our second Global Fixed Income Survey1 shows managers’ forecasts are mostly clustered in a narrow range. The tightest consensus of all is for 2-3 Fed rate hikes in the next 12 months. The survey indicates few pockets of value, though Emerging Markets (especially Local Currency Debt) score very positively, and there is one standout cheap currency (the Mexican Peso, highlighted by over 40% of the EM managers and over 30% of the currency managers).
When we analyse the respondents’ average expectations for the terminal Fed Funds rate and for inflation, we derive a very low number for forecast economic growth. Normally, this would in due course prove challenging for credit investors and for equities too. We believe this reinforces the case for multi-asset investors staying well diversified and ready to make changes nimbly.
100% of respondents expect either 2 or 3 Fed rate rises in the next 12 months. Almost 80% expect the next rise to be in Q2, and 74% expect inflation in a narrow 2.0%-2.4% range. A very similar number of respondents expect a steepening of the yield curve to a flattening of the yield curve, indicating a market perceived broadly as fairly priced. The most common forecast for the peak Fed Funds rate in this cycle is 2.26% to 2.50%, in a band ranging from just 1.26%- 4.00%. That contrasts with a more ‘normal’ average level of rates of around 4-5% from the mid-1960’s to 2008, and highlights the current manager consensus that the economy remains in an era of low growth and low inflation. In fact, we infer from the manager responses a prospective US growth rate of just 0.5% and a high probability of recession in the medium-term. Tell that to equity investors, who have sent the S&P 500 to successive highs on a wave of Trump-phoria!
In spread sectors, most respondents opted for stability. ‘Range bound’ was the most popular answer in both US High Yield (65%) and Global Investment Grade (35%), with barely any outliers beyond ‘moderate tightening’ or ‘moderate widening’. Correspondingly, securitised managers mostly opted for ‘maintaining risk position’ when asked whether they were adding or reducing risk over the next 12 months, although 57% voted for ‘modest spread tightening’ over 35% ‘range-bound’.
Across industry sectors, global leveraged credit managers indicate that the risks to energy, mining and healthcare issues have been mostly priced in. Their worry list is now headed by retail, with 52% voting this the most concerning area. Overall, they remain positive on the US economy (55% voted for either ‘modestly’ or ‘materially’ improving). The Global IG managers remain modestly positive also, with 62% stating that current credit spreads compensate for deteriorating credit fundamentals either wholly (28%) or to some degree (34%). All the Global IG managers expect to beat cash over the next 12 months.
US Muni managers are split exactly 50/50 on whether High Yield Munis would out or underperform Corporate High Yield on a 12-month view. Typically, High Yield Munis should underperform on a before tax basis given the tax break they get, so a 50/50 view is a positive tilt towards High Yield Municipal. As High Yield Munis yield 109% of U.S. Corporate High Yield (as of February 16, 2017), we see the income advantage as the tie-breaker, particularly for tax sensitive high net worth investors.
In currencies, most respondents forecast fairly modest ranges in particular for GBPUSD and USDJPY on a 12-month view. However, they expect greater volatility for both G10 (83%) and EM (67%) currencies along the way.
EM was the brightest spot. 76% of EM Hard Currency managers expect either range bound or modestly tightening spreads. Only 18% of managers expect a big hit in 2017 from default by Venezuela. Even so, Local Currency Debt is overwhelmingly seen as the better performer on a 3-year view (92%), buoyed by positive currency (85%), cheap or fair value rates (100%) and stable or lower inflation (81%).
Overall, we found relatively few high conviction ideas in our Q1 survey; perhaps the most interesting finding was the potential disconnect between the managers’ views on US economic fundamentals and the outlook for credit (and equity) markets. Our response is to keep focused on effective diversification and dynamic allocation in our multi-asset strategies.
1This quarter’s survey featured 182 responses from managers with specialisms ranging across Global Rates, Global Investment Grade Credit, Global Leveraged Credit, Securitized, US Muni bonds, Active Currency, and Emerging Markets (both Hard Currency and Local Currency Debt).