Singapore Retail Investors
Markets in general spent the second half of 2016 firmly in ‘political event’ mode as first Brexit and then the US election took all the focus and drove market sentiment. The expected US fiscal stimulus under the new President and the multiple elections in Europe in 2017 had markets start the New Year still on ‘political watch’. Economic fundamentals and central banks were background stories at best – even though the US Federal Reserve (FED) tightened policy in December, they were still not perceived as the main game in town. It didn’t last. Central bank policies are back to the forefront of the markets mind.
Markets move quickly. Two months ago, “How fast, how much and what chance?” were the questions being asked about US tax cuts, infrastructure spending and various reform measures, together with the rise of populist anti-European Union candidates in the Dutch and French elections. Now it refers to US Fed policy tightening and balance sheet reduction, ECB further tapering, and BoJ policy adjustments. Uncertainty still rules on many fronts, particularly with respect to European politics, but shifts to the central bank policy landscape are firmly in focus.
Just like a child’s favorite question as the family sets out on a long holiday drive is “Are we there yet?”, central bank policy makers are increasingly asking themselves the same question. In their case, the “there” is full employment, inflation targets and a self-sustaining growth momentum. The answer in some cases might be the same as that given by the parents in the front to the children in the back… “nearly”. And if they are “nearly” at objectives, then emergency or crisis level policy settings don’t seem appropriate. The improved economic picture is allowing developed market central banks to start contemplating exits from these super accommodative policies. The US Fed has been trying to find a way to move away from such settings for the past two years, only to be foiled at various times by external events.
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.
Despite dot plot expectations of two or three each year, the Fed managed to only tighten once in each year. We are back “there” again. This time however, it may be for real given an almost universal hawkish rhetoric from Fed members from mid-February up to the recent March policy hike, plus the expectation for two further moves in 2017.
With expectations for another hike in June and one more in September, that would make four consecutive quarters in a row, counting the December 2016 move. Does moving from one a year to potentially four within a year still count as a gradual Fed? If it is accompanied by a continued broad-based improvement in global growth, it probably does. Meanwhile, over in Europe, economic data has shown upside surprises and improved the outlook, such that further tapering of QE is likely by year-end and deposit rates may increase. Provided politics doesn’t intervene.
How has the market expectation of the level of the Fed Funds rate in December 2017 changed?
So what should an investor in fixed income do in this environment?
We expect the lack of income 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. Credit spreads have remained very well-supported in the first part of the year despite bond yields generally rising (though not at a fast pace and unlikely to be significant in our view). Investors should likely prefer shorter maturity securities to reduce interest rate sensitivity. It also means that high yield bonds – typically relatively uncorrelated to interest rates and companies that should benefit from better underlying economic conditions – will also have a solid role to play in the portfolio.
USD-denominated Asian credit fits into the above preference relatively well. Whilst spreads have fallen, we expect to 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. Returns won’t be as strong as last year, but they should still be solidly positive.
Clearly there are no certainties. Politics, as they have so often done in the post GFC world, could easily come back to haunt the best laid plans of the world’s central banks. However, the underpinnings of the global economy certainly seem better at this point than at any stage in the past few years, and certainly better than the deflation fears of only a year ago. Reflation, not deflation, is the catch cry now (markets love simple themes), or maybe it’s just a return to some form of normalcy after a decade long work out of the pre-GFC credit bubble, but whatever the explanation, central banks are increasingly happier to answer the question about arriving at the destination.