Positive on corporate debt

Institutional Money (03.09.2021) - This year, we have held – and continue to hold – a positive bias on credit markets. This has been driven by our macro scenario of a robust and sustained global growth recovery as economies normalise following the vaccine rollout, coupled with the significant policy support coming from both monetary and fiscal authorities which should allow global growth to exceed its pre-Covid trend.

The US Federal Reserve surprised markets recently by making a hawkish pivot through its updated dot plot projections, which now indicate two hikes in 2023 compared with their prior dot plot which showed no hikes. In addition, 7 of the 18 board members already see a hike in 2022. Fed Chair Jerome Powell also confirmed that the committee have begun initial discussions on tapering off their large-scale bond purchases, which will probably advance as the year progresses.

This hawkish outcome was driven by the Fed’s increasing confidence in the economic outlook. The Fed is reacting to a strengthening consumer, where demand has been fuelled by unprecedented amounts of monetary and fiscal support.

Whilst labour market gains in recent months have been slower than anticipated, the Fed is confident that jobs growth will continue, as enhanced unemployment benefits that are beginning to expire in some states in June will be fully expired by September, thus forcing individuals to return to the labour market.

For several months now, we have been positioned with a structurally defensive interest rate exposure across our fixed-income portfolios and this positioning has benefitted from the recent Fed meeting. We see this meeting as the Fed looking to close the gap in pricing between themselves and the market, and from here we expect it to also limit the downside in US government bond yields, where the recent lows in rates should define the bottom of the range. Interest rates remain a risk, particularly for longer-dated maturities, and products that do not manage their interest rate exposures, such as ETFs and tracker funds, may see capital losses as rates continue to rise across the interest rate curve.

In terms of credit, we remain positive and continue to maintain an overweight position.

We see a Fed that is now no longer significantly behind the curve as reducing one of the major tail risks that investors have been concerned about, namely that of sustained inflation above their target which could potentially have led to violent moves on the rates markets and contagion into credit markets. Instead, this hawkish pivot by the Fed looks as though it will dampen fears of excessive inflation in the medium term, and the market has responded with forward-looking inflation instruments falling since the FOMC meeting. Given the global economic growth path is now expected to exceed the pre-Covid trend, in tandem with the significant and continuous monetary and fiscal stimulus measures, credit continues to be attractive, with the distinct possibility that those fixed-income credit markets where spreads have not returned to their pre-Covid lows will do so.

We take the recent moves by central banks – and the Fed in particular – as confirmation of our defensive bias on interest rates along with a constructive view on credit, in particular high yield and AT1s, and expect to continue to hold these positions in the medium term.

Philippe Graüb
Head of Fixed Income
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