AA UNION CAPITAL - Fixed Move income to neutral duration in USD & GBP portfolios

[CryptoYears]

Given the risk environment and advanced stage of Fed tightening, we now favor a neutral duration in USD and GBP.

Credit is set to outperform government bonds, but volatility is likely to be high in Q4.

Sylvie Golay Markovich Head of Financial Markets Strategy

Global fixed income markets were almost flat in the past month. Investment grade credits outperformed government bonds, supported by better returns for USD corporate bonds. Emerging markets (EMs) continued to lag, with local bonds suffering significant losses, especially in USD terms as the crises in Turkey and Argentina spilled over to other markets such as South Africa.

Risk environment set to remain challenging Going into Q4, global growth should remain solid, which should allow the Federal Reserve (Fed) to hike interest rates twice more this year. After the expected hike in September, the Fed tightening process will be well advanced, as evidenced by the very flat USD yield curve. With the GDP Now growth tracker suggesting Q3 GDP of over 4%, some deceleration in US hard data looks likely in the coming six months. Moreover, the trade and risk environment remains challenging, which could cap a potential increase in USD long-dated yields (our 3-month forecast for the US 10-year yield is now at 3%). We therefore no longer recommend a short duration positioning, but take a neutral stance of slightly below 4 years. We also neutralize our short duration positioning in GBP. After the Bank of England’s last rate hike, Brexit headlines should be the main yield driver. We thus prefer to express our expectation of a soft Brexit through the currency.


 
Convertible and EM bonds for risk-tolerant investors The positive economic trajectory we expect should support earnings growth. We, therefore, keep our positive view on convertibles, even though volatility in risky credits should remain high. Fundamentally developed market credit metriAAUC continue to point to a benign default outlook, supporting our preference for investment grade over government bonds.

In EMs, while economic growth should reaccelerate, credit fundamentals are likely to deteriorate, supporting our preference for sovereign over corporate bonds in hard currency. EM local markets could remain under pressure until there is greater clarity on trade and we see economic adjustments following the recent currency depreciation. Still, rate and currency valuations are at extreme levels, highlighting the divergence of asset pricing and fundamentals. A good example is South Africa, which we expect to eventually recover. Yet our view on Brazil is now negative, with BRL yields expected to increase further.

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