2019 Outlook: Fixed interest
2019 Outlook: Fixed interest
Covering Continental Europe
- 2018 saw a re-pricing of some parts of the bond market, which has created some value.
- Fundamentals within the banking sector generally remain good heading into 2019.
- Challenges remain that could see further volatility and potential investment opportunities during 2019.
As we look ahead to 2019, the US economy is, in my view, in pretty good shape. However, with the fiscal stimulus that has been such a driver of recent growth coming to an end and trade tensions an ongoing concern, economic growth has likely peaked and could now fade. Meanwhile, despite the structural arguments one could make for inflation to increase, we are, so far, yet to see any meaningful pick-up in the rate of inflation.
Against this backdrop, the US Federal Reserve is three years into its current hiking cycle. As US yields have adjusted to a higher Fed Funds rate, so too has the balance of risk and return for US government bonds. That is not to say that yields might not rise further than current levels – clearly, they could. Rather, the compensation for taking US duration risk has increased making the US a potentially competitive source of income. In turn, this has led investors to demand a higher premium to invest in more challenged areas of the fixed income market. At times over the past 12-months this re-pricing has created opportunities that we have sought to exploit.
As the challenges of tightening monetary policy and global trade play out over the coming year, I would expect further tactical and strategic investment opportunities to present themselves. The flexibility to be able to exploit such opportunities will, I believe, be important to delivering returns in what could be another difficult year for bond markets.
I think 2019 will initially be a continuation of what we have seen in 2018. The Federal Reserve look set to continue their policy of gradually tightening US monetary policy. Meanwhile, uncertainty over trade, the Italian government’s budget deficit, Brexit and emerging markets remain potential catalysts of further volatility.
That said, I think we begin 2019 with bond markets better placed than they were at the start of 2018. The volatility of the past 12-months has seen some value come back into parts of the market and as a result there are now some relatively attractive yields that can be found. This not only helps when we’re trying to get income for the funds, but it also means that there is now more of an income cushion during periods of price volatility.
One area where I believe the re-pricing has created some value is the AT1 market and I have, where appropriate, been seeking to add exposure. Elsewhere, the rise in US yields is a positive for US corporate bond markets. Currently, I think the best opportunities within this market can be found in bonds maturing in 7-10 years, but if US yields move significantly higher, then this could start to open-up opportunities further out the curve.
Summing up, I don’t think we are yet at a point where we can say the market has become cheap, but I do think we can probably say that the market has become more rational. I think there is a sense that the balance has started to tip away from borrowers and toward us as investors. So, while I remain cautious, I am slightly more constructive on the asset class than I have been in previous years.
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