Fed’s normalisation cycle will be gradual, says Fidelity Global Fixed Income CIO
Hong Kong, 30 July 2015:As we head to year-end 2015, US fundamentals continue to suggest a December start for the Federal Reserve’s long anticipated rate normalisation cycle, albeit at a very prudent pace, says Andrew Wells, Global Chief Investment Officer, Fixed Income, Fidelity Solutions and Real Estate, Fidelity Worldwide Investment. “Once rates start rising, we believe that the Fed will act cautiously and take a very slow and careful approach, with further hikes data dependent.”
Mr Wells cautions that an element of uncertainty remains, and investors must track not just relatively supportive data like unemployment, but also less bullish indications like wage pressures and tepid inflation figures.
“The Fed may prefer to remain behind the curve, allowing for higher inflation to materialise in the short term in an effort to continue supporting growth,” says Mr Wells.
“However, interest rate increases are already in the price and the curve is steeper than the average seen at the onset of tightening. So in many ways, markets are prepared for lift-off” adds Mr Wells.
Central banks in Europe, China and Japan are expected to continue their easing programmes, which will remain supportive for bond markets in the next 6 to 12 months. “The European Central Bank is unlikely to end its QE programme prematurely as inflation is low and the Eurozone growth outlook is delicately balanced,” says Mr Wells.
Bryan Collins, Portfolio Manager, Fidelity Worldwide Investment, adds, “We believe Asian central banks, including the People’s Bank of China, will ease further in order to support economic growth, supporting Asian credit markets and especially RMB bond returns.”
Liquidity Remains a Challenge
“Other than central banks’ policies, liquidity is another key theme that fixed income investors need to watch,” Mr Wells says. “Central banks’ quantitative easing (QE) programmes and increased banking regulation have reduced market liquidity and made it susceptible to sharp price changes, both to the up and downside.”
Mr. Wells adds, “Poor liquidity has kept intraday volatility elevated. This combined with stretched positioning by investors, rather than fundamentals, has been the main driver of the recent weakness in government debt markets”.
“To protect against the volatility, strategic bond investing can help to reduce concentration risks to individual market segments and can be a useful way for end investors to better protect themselves.”
Mind the Corporate M&A Market
Investors also need to pay attention to increasing corporate merger and acquisition activity. “Corporate leverage in the US continues to rise rapidly, thanks to a large amount of issuance pre-Fed hike and a busy M&A calendar. The situation is not as positive for US Investment Grade credit,” says Mr Wells.
“In spite of the weakening in corporate fundamentals, valuations in investment grade credit are supportive. For instance, credit spreads are today wider than they were at the onset of previous Fed tightening cycles”.
US Hike Has Limited Impact to Emerging Market Debt
Risk reduction in the last month has seen emerging market (EM) bonds give up some ground, but according to Mr Wells, investors should look closely at opportunities in hard currency corporates in particular.
“In the current low yield environment, EM hard currency corporate bonds are attractive for investors, given comparable yield and relatively low duration, volatility and default rates compared to many other assets.
Mr Wells says his view runs contrary to prevailing expectations that weaker emerging market currency values will expose the corporate asset class to a US dollar funding burden.
“This is in part because sovereign issuers in the emerging world are considerably less exposed to foreign currency debt than at the time of the last currency crisis in the late 1990s,” says Mr Wells, “Equally important to limiting the impact the Federal Reserve’s eventual policy change will have on emerging market debt is how successful the Fed is in communicating both its pace of policy and the eventual ceiling on the rate level.”
Chinese Volatility from a Debt Perspective
Much global attention has fallen on the recent volatility in Chinese equities, but for fixed income investors, the fundamental story remains intact, says Mr Collins.
“As the Chinese government continues to promote the onshore RMB bond market, we continue to see institutions diversify their funding sources and simultaneously reduce their cost of funding, which is extremely supportive to both fundamentals and offshore credit market technicals,” Mr Collins says. “RMB bonds also offer attractive risk adjusted returns as the currency will remain relatively stable and onshore interest rates will move lower still making the asset class an appealing proposition for global investors.”
About Fidelity Worldwide Investment
Fidelity Worldwide Investment is an asset manager serving investors in 25 countries across Asia-Pacific, Europe, and Latin America. With USD $285 billion assets under management (AuM) and around 7,000 employees, we are one of the world's largest providers of investment strategies across asset classes, and retirement solutions. Investment is our only business, and our mission is to enable our clients to achieve their financial goals through outstanding investment solutions and service. (Data as at 31 March 2015)
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