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Fixed Income: Core Appeal, but not Time to be Overly Defensive

September 18, 2018

Overall assessment

The appeal for core bonds continues due to both the geopolitical tensions and erupting idiosyncratic stories in EM. The Turkish crisis is the latest in signalling that conditions have become tougher for EM debt. Selectivity is increasingly the name of the game to limit the effects of country-specific vulnerabilities and imbalances. As the tide that lifts all boats, notably ultra-accommodative monetary policy, is approaching an end and financial conditions become tighter, investors should continue to explore opportunities in credit, but with a more cautious attitude in the areas of the market that benefit most from the buyers of last resort (CBs), notably low quality/low liquidity bonds. We are still cautious on duration, but, especially in the US, investors should consider reducing their shorts as we move closer to a neutral rate.


Developed Market Government Bonds

The 10Y German bond yield remains anchored to year-to-date lows, benefiting from the flight to quality effect as a response to the Turkish crisis (with a potential impact on European banks) and tensions on Italian govies. The next weeks will be critical for the Italian budget law and noise will remain high. The Italy-Spain spread being close to historical peaks means markets are confident about the ECB’s toolkit to reduce contagion risk. We don’t believe that these frictions will impact on the ECB’s announced plans. Eurozone CPI is close to the CB’s target and economic conditions remain sound, despite some challenges. Hence, in the tug of war of idiosyncratic stories and sound economic conditions, we expect core rates to remain in the current trading range.

Developed Market corporate bonds

We have taken a more conservative and selective approach on credit in recent months, even if we do not think it is yet time to be too defensive. Investors have started to price in a peak of global economic activity, less supportive technical conditions and diverging fundamentals between the US and Europe. EU companies continue to be very cautious, with low leverage and high cash ratios. US companies remain confident in the economic cycle, increasing leverage and decreasing their cash ratios.

 

We prefer short-term maturities/floating rates and higher quality bonds. Opportunities are rising in subordinated bonds in Europe, but again a focus on selectivity is paramount.

Emerging Market Bonds

We remain prudent at the moment, as some political noise is expected ahead of Brazilian elections in October. Our preference is for hard currency bonds over local currencies due to valuations, the risk-off environment and EM FX fragilities versus the USD. Our favourite picks are Mexico (agreement with US on trade and attractive risk/return profile in local currencies (LC) sovereign debt), Serbia (good fundamentals and appealing risk/reward) and Argentina (after the IMF support). We are cautious on Turkey (LC). We don’t expect US sanctions on Russian sovereign debt, but volatility will remain high. Through the year-end, when we expect easing trade tensions and a stabilisation of the USD, EM bonds will be back in focus, with attractive yield premiums for long-term investors.

FX

The USD should remain well supported in the short term versus main currencies thanks to the US economy’s strength and CB divergences. However, US elections in November could weigh on the greenback, giving some relief to EM FX.

 

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Important Information

 

The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages. (www.mscibarra.com).

 

Diversification does not guarantee a profit or protect against a loss.

 

Unless otherwise stated, all information contained in this document is from Amundi Asset Management and is as of 17 July 2018. The views expressed regarding market and economic trends are those of the author and not necessarily Amundi Asset Management, and are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Asset Management product. There is no guarantee that market forecasts discussed will be realised or that these trends will continue. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any services.

 

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Contributing Authors

Ken Taubes
Chief Investment Officer, US, Amundi Pioneer

 

Yerlan Syzdykov
Head of Emerging Markets, Amundi

Eric Brard
Head of Fixed Income, Amundi