Fixed income markets have had a somewhat challenging end to 2016 with US and global government bond yields undergoing a sharp move higher post the US election. This is largely due to a shift in market perception of what the new US administration “might” do, rather than any certainty of what they will do. There are many open questions, and if 2016 was a year where political risk created a feeling of change, then 2017 promises to reinforce this air of change and uncertainty given the political calendar. In the modern world, change is constant and rapid, and the outlook for fixed income in 2017 shapes as being very much in that theme. Brace yourself for more.
The past year has seen two largely unexpected outcomes. First there was Brexit and then came Trump, which neither markets, media, or polls saw coming. In those two events, the world changed, the problem at the moment is though, we don’t know how much – neither has actually been implemented or installed in the job.
Even before the recent market focus on the potential for fiscal stimulus driven growth, 2017 was already forecast to have global growth rising for the first time in many years, driven by a pickup in oil related investment, stronger US growth and a strong rebound in some important emerging market economies. Markets have seized on the growth focused message from the incoming President, and also from the sense that the US Federal Reserve will ‘let the economy run hot’ in order to achieve its inflation goals. Or maybe they were just desperate for a ‘theme’ to trade given the past few years have been plagued by a stop-start picture of economic activity and approach to policy.
Even before the recent market focus on the potential for fiscal stimulus driven growth, 2017 was already forecast to have global growth rising for the first time in many years, driven by a pickup in oil related
Ashley Perrott is Head of Pan Asia Fixed Income within UBS Asset Management and has over 30 years’ experience in fixed income markets. He and his team are responsible for the portfolio management of all Asian fixed income funds and mandates, covering both hard and local currency strategies. This also includes country specific portfolios, such as onshore China fixed income investments.
investment, stronger US growth and a strong rebound in some important emerging market economies.Markets have seized on the growth focused message from the incoming President, and also from the sense that the US Federal Reserve will ‘let the economy run hot’ in order to achieve its inflation goals. Or maybe they were just desperate for a ‘theme’ to trade given the past few years have been plagued by a stop-start picture of economic activity and approach to policy.
Whichever the case, confidence in the outlook is high. But so is uncertainty. It is worth reminding ourselves that actually nothing has happened as yet in terms of concrete policy initiatives. We don’t know whether the cyclical pickup will be anything other than temporary given the structural headwinds in both advanced and emerging economies. Nor do we know whether the current anti-globalization and anti-trade rhetoric will remain just that or whether it will be reflected in actual policies causing more damage. What’s even more unclear then, is how monetary policy makers will react to a changed environment. Given all the uncertainties, and before we all get too carried away, there is little reason to expect that 2017 will any be less volatile.
So what should an investor in fixed income do in the coming year?
Despite the recent increase in bond yields, it is worth remembering that trillions of dollars of the world’s bond market still have negative yields. In fact, as of mid-December, for 28% of all outstanding developed market government bonds, investors were accepting a negative return until maturity. Therefore, we expect a lack of investment opportunities in a number of major markets to remain a big challenge for investors and that credit related securities in both DM and EM will continue to be an attractive alternative. At least higher coupon returns will help offset the negative impact of potentially higher bond yields. The risk of a rising yield environment also means investors should prefer shorter maturity securities
to reduce interest rate sensitivity and that high yield bonds – typically relatively uncorrelated to interest rates and of companies that should benefit from better underlying economic conditions – will also have a solid role to play in the portfolio.
In an environment of a likely strengthening currency, USD denominated Asian credit fits into the above preference relatively well. The opportunities coming from both investment grade and high yield Asian bonds will likely see ongoing investor interest, supported by an investor base both in the region and outside the region that continues to look for places to find yield and income. Whilst strong performance in the past year has made valuations more elevated than this time last year, they are not extreme, and the technical picture remains supportive for spreads.
Markets would appear to be at an inflection point and the transition from monetary policy to fiscal policy, if it happens, is a big change to the landscape that investors have operated in over the past eight years. That likely will change the way investors think about their portfolio. But one thing the past eight years has taught everyone, or at least should have, is that you can’t get too dogmatic and tied in to a view of how markets will perform and a diversified portfolio is essential. Circumstances change rapidly and investors need to stay nimble. 2017 is likely to be no different.