Who could be the winners and losers in the world of fixed income?

Federico Kaune (FK): EM credit spreads are at levels comparable to the 2008/2009 crisis. Spreads haven't tightened in part because developed market central banks are not directly buying EM credit. Spreads are pricing in broad defaults, the lack of capacity and willingness of emerging economies to pay, none of which is likely to be realized. For investors with a medium to long-term horizon, there are opportunities to lock-in high spreads.

Short-term, we expect continued volatility in EM credit and currencies because of the uncertainty surrounding global growth, commodity prices, capital flows and the policy responses from these countries. But if one is willing to take a longer-term view, I believe there is value in credit.

Craig Ellinger (CE): We have seen an increase in risk-taking as result of the Fed's actions. In March, the Fed has announced several new support programs and dusted off some old ones. On the quantitative easing front, they recently purchased approximately USD 1.6 trillion in US Treasuries and USD 600 billion in mortgage-backed securities. The purchase of these high quality assets essentially stabilized the markets and improved overall market liquidity. The Fed hasn’t bought any corporate or HY bonds yet, but by announcing their intent to do so, they have effectively provided a backstop to the credit markets. It has become much easier for us to buy and sell bonds of all types.

Jonathan Gregory (JG): The US was in a strong economic position going into the recession, which will help in dealing with the crisis. The Fed and the Treasury are working in harmony, with the Treasury providing the equity and the Fed providing the debt. There isn’t quite that harmony between the European Central Bank and fiscal authorities, although it may come.

Perhaps the biggest challenge to the US emerging as a winner is the risk of mis-timing its lockdown exit and the risk of second wave infections. Also, if the US fiscal response gets too large and becomes outright debt monetization, inflation could rise higher than expected or desired.

CE: HY bond spreads have moved since the peak in March from around 1100 bps to 800 bps today, but haven’t retraced as much negative performance as the equity markets have. HY spreads have stalled for several reasons. Fundamentals were already a bit stretched coming into the COVID-19 crisis, and as companies try to cope with it, there is a high probability corporate leverage will increase as revenue and cash flow deteriorates. Defaults are expected to rise. The supply of HY debt is also expected to increase dramatically as fallen angels lose their investment-grade ratings. Also, while improved, liquidity in the HY market is not nearly as good as what has been observed in other markets segments. While the Fed has announced the purchase of HY ETFs, we don’t know how this will actually pan out in practice. We probably won't see further spread tightening until the Fed is more explicit in their plan of HY purchases.

JG: We believe TIPS (Treasury inflation-protected securities) are a good opportunity.

Over the past 10 years, we've been used to inflation not being an issue, for a variety of mostly structural reasons so even before the COVID-19 pandemic, central banks were getting more serious about finding ways to move inflation higher. The goal of governments and central banks will be to drive real yields as low as they possibly can to avoid tightening in financial conditions. Couple that with the truly extraordinary levels of fiscal support we're going to see from August on, the likes of which we haven't seen in our lifetimes. While we will be in a deflationary world over the next few months, there's no question that the risk of inflation will increase thereafter. A decent amount of inflation protection in portfolios makes sense. The 5-year bond looks like a particularly good value at current price levels.

JG: Personally I don't think this is an existential crisis for the eurozone.

If you are an EU politician disappointed with level of support received from richer countries, it is still hard to articulate a scenario in which you would be better off outside the eurozone. We may not like the way the EU goes about dealing with a period of crisis, but it comes through. There's not a politically credible world outside the eurozone for many countries. Maybe that will come in the future but it's not now.

The European Union does have the institutions to organize a coordinated fiscal policy response to a crisis like COVID-19. The European Central Bank is doing all the right things. I think potentially in the short term at least, the peripheral eurozone members could be among the winners from the ECB's support programs.

CE: We remain positive on the investment grade (IG) corporate space, particularly in USD. The Federal Reserve has announced unprecedented policy measures to directly support that market through two new credit facilities which should result in considerable spread tightening. We like higher quality credit in general, which includes asset-based securities and mortgage-backed securities. Within IG, we prefer the banking, healthcare, media, and technology; each of which should perform in the current environment.

JG: The trades we like are in global credit right now. Generally our mantra is to buy what the central banks are buying. As the Fed buys primary and secondary issues, including fallen angels it is underwriting financial stability in the credit markets. We view the IG market outperforming the HY market, we like quality IG names in single A and above and we particularly like the 5-year part of the curve.

FK: The US dollar sovereign spread curve is very flat in IG and inverted in HY. We are not getting paid to extend duration unless its investment grade, the value is in the short-end of the curve – the 3-5 year spread over US treasuries for HY and the long end of the curve for IG. Overall, there is a compelling yield differential between EM and DM countries.

JG: It’s a similar story for the US yield curve. We buy what the central bank buys which is the 5-year point on the corporate yield curve.

We do not expect much US yield curve steeping as its highly likely the Fed policy toolkit will be expanded to include yield curve control measures which flattens the curve.

FK: We favor China within the EM space and like the local rates since the central bank has implemented many policies to help with the recovery in addition to opening up its markets to foreign investment in recent years. The government has announced no defaults will take place in China in 2020, providing much needed support to companies. China bonds are increasingly included as a constituent in global indices such as Bloomberg Barclays and JP Morgan Bond Indices which will generate huge investment into the country’s bonds.

FK: One has to differentiate among different groups. We like some of the larger, mainstream emerging markets countries. There is value, especially at the longer end of the local curve, where 10-year bonds are yielding between 6% to 9%. The most vulnerable countries are low income countries with limited access to international capital markets. Some of the oil-exporting countries are under increasing stress due to declining oil prices, but it is important to differentiate here as well. Some manage their dependence on the oil sector very well and remain in a good position.