The climate for Fixed Income in 2018

By William Fong - March 7, 2018

I recently attended the ANZ Debt Conference in the Hunter Valley (during the final week of February). Over 200 investors and Corporate Bond Issuers were packed into the Crowne Plaza Resort at Lovedale NSW, during the two and a half day gathering.

Read: The full Investment Month in Review February 2018 Newsletter

Read: Reporting period wrap – earnings trending higher

Domestically, Australia had a total of A$6 billion worth of new issuances during 2017. It was an incredible year for almost every class of asset under the investment radar. The decade of ultra-low interest rate had lifted equity, bonds, property and even cryptocurrencies to highs not seen ever before. But as the recovery is slowly shifting its gear into the expansionary phase, the fear of a higher real rate of interest is finally weighing on the climate for investing.

The general expectation from the “smart money” at the conference was that the credit market would take the lead on the equity market by anywhere between six to nine months. Hence, if we see a real blow up from credit spreads (due to the fear of raising interest rate), then the equity market will stay weak for some time to come.

Macro Environment:

The flattening of the yield curve over last decade had pushed investors’ appetite further away from the safe haven aspect of Fixed Income, towards the crossover spectrum between bonds and stocks. Portfolios are now much more concentrated in High Yield and other Loss Absorbing Capital (TLAC) instruments. But a few major global developments will set the path for 2018 and beyond:

  1. U.S. Federal Reserve has begun offloading its massive USD 4 trillion balance sheet holding of US treasury bonds and mortgage backed assets.
  2. Bank of Japan is beginning the unwinding of its almost three decades long Quantitative and Qualitative Monetary Easing (QQE).
  3. European Central Bank finally lifting government bond yield out of the negative nominal zone.
  4. China tightening onshore liquidity to restrain the expansion of corporate borrowing and the outflow of funds outside of the borders.
  5. U.S. attempt to repatriate outward invested money via tax incentives and Trade Tariffs/ Barriers.
  6. U.K.’s BREXIT negotiation with the EU, and how it’s marginalised the once major economic powerhouse.

Conclusion:

The investing environment will be a lot more challenging in 2018 vs the previous 12 months. Volatility is here to stay and will most likely pickup more aggressively despite healthy economic data. The interest rate environment will determine the speed of which various asset classes retract from the decade long rally. Credit quality and stock picking will be crucial for a fruitful investment portfolio, lighten your duration and shift into higher ranking rating space will avoid much turbulence. 


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