Quarterly Fixed Income Survey: Life with Trump

News of a Trump Presidency sparked a rise in government bond yields that reverberated around the fixed income world. At this pivotal moment, our first Global Fixed Income Survey took the temperature of a wide range of fixed income markets, based on the views of around 150 responses from specialist bond managers across different segments. Broadly, their views were very modestly positive across Investment Grade (IG) and Emerging Markets (EM), and modestly negative across Global High Yield (HY). Managers of US Municipal Bonds (Munis) were predominantly negative.

One of Russell Investments’ assets is its unique position in the market and its ability to talk to other asset managers. We want to leverage this natural asset to give our clients better insights into the markets and the industry. From our first fixed income survey there are some interesting outcomes, but in the immediate aftermath of the US Presidential election it appears managers are mostly lacking strong conviction.

IG managers are still positive on credit spreads, with 43% expecting moderate tightening versus 30% expecting widening. Interest rate risk registered as only ‘slightly concerning’ for over 60% (versus 33% ‘concerning’ or ‘very concerning’) after the post-election sell-off. Over 75% expect IG to beat cash over the next 12 months. The managers’ most preferred market was the US, in spite of the higher leverage levels. Emerging market credit was one of the least liked, perhaps unsurprisingly given a strengthening US Dollar and ‘America First’ trade meme. Interestingly many preferred Subordinated Financials (a sector that underperformed significantly at the beginning of the year) over other sectors, reflecting a perceived more favourable outlook for banks under the Trump administration.

EM hard currency managers also on balance expected modest spread tightening, and over 85% believed their markets remained ‘fairly’ or ‘selectively’ liquid. EM Local Currency managers were bullish on their prospects versus their Hard Currency peers, particularly on a 3-year view (92%). They were correspondingly bullish on local rates (46% ‘cheap’, 43% ‘fair value’) and either ‘slightly’ or ‘strongly’ positive on EM currencies versus the US Dollar (86%). The major worry across EM generally was a China Hard Landing, with Fed rate rises top equal for EM Local Currency respondents.

Conversely in HY, a balance of 10% expected moderate or significant spread widening versus tightening (21% opted for ‘range bound’). Despite well-publicised concerns over corporate leverage, 57% of respondents noted only ‘modest’ deterioration in corporate fundamentals (e.g. leverage, interest cover and cash-flow) with none noting ‘alarming’ deterioration, and 25% noting modest improvement. Default risk generally was not a major concern. Only 4% expected a peak in the default rate in 2017, with 36% identifying H2 2018 as the prospective peak and 40% claiming the peak is already behind us. Consequently 79% were maintaining their current risk posture for the foreseeable future. 39% named Healthcare as the sector most vulnerable in terms of not being priced for the associated credit risk (any efforts to repeal, replace, or revise the Affordable Care Act could have widespread impacts on credit risk across the sector) with Energy sectors (perceived to be highly leveraged and vulnerable to a further down-leg in prices) second worst at 38%.

Across Muni managers, more respondents expect higher yields after the election, (50% opted for either ‘significant’ or ‘moderate’ increases versus 43% range-bound) and 70% believe muni HY will underperform corporate HY. 79% of respondents expected 30 year AAA Munis to be priced in a narrow range (95%-110%) around the equivalent Treasury bond (i.e. at a similar level but with additional tax benefits for higher-rate US taxpayers).

Overall, our first survey bore some of the marks of the new administration, but without really decisive levels of conviction for most responses. Time and future surveys will tell if the new US President will be as good (or as bad) as his word.