Portrait of Charlotte Baenninger

Charlotte Baenninger

Head of Fixed Income
Our preference remains for US rates over other developed markets. Within credit, we have locked in some profits in both Investment Grade and High Yield (HY) by selling Asian HY exposure.

The US Federal Reserve's decision in January to pause rate hikes have helped lift risk assets so far in 2019. How do you believe this will play out in the second half of the year?

Fixed income markets have seen strong performance year-to-date, surpassing what we and consensus had expected at the start of the year. Given the dovish tone that central banks have adopted globally, carry is expected to continue to generate positive contributions to total returns for the remainder of 2019, however downside risks remain with Brexit being pushed out to the autumn and still no tariff deal between the US and China.

Within fixed income, where can investors find the best opportunities?

We continue to see selective relative value opportunities across developed interest rate markets although we expect this to be more muted than previously as major central banks are expected to remain on hold, thus providing less divergence. Our preference remains for US rates over other developed markets. 

Within credit, we have locked in some profits in both Investment Grade and High Yield (HY) by selling Asian HY exposure, and scaled down risk, given that spreads are trading at the low end of our range targets. Valuations look fair and in parts even rich. It is, however, possible that strong technicals (less supply than demand) might still push spreads somewhat tighter. We recommend strategies to be carry neutral while being slightly under-risked and believe that owning higher quality short duration HY bonds can help achieve this.

The dovish stance by the Fed has also supported the rally in emerging market debt (EMD) as valuations are no longer cheap and we therefore expect range-trading on the USD debt for the remainder of the year. We also favour a carry strategy in EMD with a slightly bullish view on Chinese government bonds.

What options do central banks have to lift inflation?

Central banks have different policy options to reach their inflation target. (Most having a 2% inflation target).

  • The central banks' conventional monetary policy tools are open market operations, the discount rate and reserve requirements with which they can influence short term interest rates and/or the monetary base.
  • Other (unconventional) forms of monetary policies such as credit easing, quantitative easing, forward guidance or signaling have been used in recent years as interest rates were already close to zero and concerns about deflation prevailed.

What risks might lifting inflation pose for fixed income investors?

If monetary policy action (for example lowering short term rates) is credible and can stimulate aggregate demand, the demand shock will lead in the short run to higher goods prices. To increase inflation longer term, growth needs to be stimulated by structural reforms as monetary stimulus alone will not be sufficient (Japan being one example). Furthermore, using monetary policies to stimulate inflation comes  with potential risks; monetary policy that is too expansive can lead to asset price bubbles or currency disruptions while an approach that is too restrictive can lead to deflation.

Why is active management so important in this environment?

The shift from active to passive management continues to be a trend in the investment industry. The transition in the fixed income space has been slower than in equities as bonds have outperformed indices compared to equities, while bonds are more complex and less straightforward to replicate than equity indices.  As a result, active bond managers have many more opportunities to outperform the index by selecting the right bonds/sectors/curve and duration strategies. Active managers need to demonstrate their value add through partnering with our investors, provide solutions and service, as well as innovation to navigate any existing and upcoming market challenges. This is the goal we strive to achieve with our experienced global fixed income team.

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