Fixed Income Monthly Report - August 2023
Preview of our monthly publication with macro themes and single bond ideas
Every month, we publish the Fixed Income Monthly report. The report is a synthesis of the Ashenden’s team view on Fixed Income, pursuing a global approach through the full spectrum of the asset class and providing bond picks. We range from Investment Grade bonds to High Yields & Emerging Markets.
In the report we disclose our bond model portfolio (6 years track record) with more than 60 individual names. We include new single bond ideas, switches, new entries and exits.
All this is corroborated by a bottom-up analysis for each single position (new and old) and merged with a top-down consideration so to include the key market drivers.
This is one of the research piece our team produces internally. The intent of the report is to support wealth managers/asset managers in their decision and allocation process.
Underlying you can find a summary of what you can find inside this report.
August edition content
Markets still see the glass half-full
July has been another solid month for the equity market with the S&P 500 up 3.1% and closing its fifth straight green month, while the Nasdaq has advanced by 4.05%. Sentiment remained strong with the narrative being the same: the risk of a recession is fading fast as the economy has proven to be remarkably resilient and the optimism around a US policy pivot associated to an easing inflation outlook has continued to support risk assets. And yet, in the bond market, the traditional warning that a downturn is near – an inversion of the yield curve – keeps getting louder. Moreover, with Amazon that just reported results beating analysts’ estimates, the bulk of the earnings news boded well for markets.
Central banks and rates pressure
During the couple of last weeks, central banks in both the US and the euro area fulfilled market forecasts by raising their policy rates by 25bps. In a clear indication of further tightening, they stated that their moves would depend on incoming data, signaling a shift to a data-dependent approach.
The US Federal Reserve raised its short-term policy rates to an upper bound of 5.5%, the highest since 2001, in the face of falling inflation. In less than 18 months, the central bank has delivered a total of 525bps of rate hikes. This has catapulted the world's primary interest rate to its highest point in 22 years. The vote for the rise was unanimous, and alongside this, the Fed has decreased its balance sheet lending by US$ 670bn while simultaneously funding a new lending program to back banks whose government securities have been devalued by the Fed’s massive rate hikes.
Last week, we also Fitch Ratings downgrading the US from AAA to AA+ in a surprise move reminiscent of S&P's back in August 2011. The rating agency had initially put the US on ratings watch back in May during the debt ceiling fight. Repeated debt-limited political standoffs have eroded confidence in fiscal management.
The European Central Bank pulled the trigger on another 25bps hike, taking the deposit rate to 3.75%. The ECB raised its own key policy rate 25bps and is on its way to raising rates 450bps in total. The decision to move on rates again was based on the view that although "inflation will drop further over the remainder of the year", it "will stay above target for an extended period". The Bank slightly adjusted its language on future decisions, and President Lagarde asserted that forthcoming policy steps would be strictly data-dependent. Ahead of the September meeting, the ECB's primary takeaway is that it is open to either pausing or continuing with rate hikes, with the choice depending on the data progression. Lagarde offered a more downbeat assessment of the Eurozone economy, noting that the near term outlook is deteriorating and momentum in the services sector is slowing.
Also in far-East things are getting hotter, with surprise brought by the Bank of Japan last week by announcing flexibility on its yield-curve control, marking a first step toward monetary policy normalization. Japan announced an incremental move to allow its 10-year government bonds to trade in a wider band between 0.5% and 1.0% (raising the rough “cap” from 0.5%).
Lastly, The Bank of England decided to raise rates by 25bps on Thursday to 5.25%, matching consensus expectations against some calls of a 50bps rate hike. There were three dissenters, two of whom voted for a 50bps increase. The MPC said current policy is restrictive but left the door open for further action if inflation persisted, and emphasized that rates have to stay higher-for-longer. The bank reduced its growth forecast for the next two years and raised its medium-term inflation outlook, suggesting the economic path will likely remain tough to navigate. Andrew Bailey said it's too soon for the UK to declare victory in the battle against inflation and that the "last mile" will require a prolonged period of restrictive interest rates.
Credit in an euphoric state
We are still in the middle of the deepest rates curve inversion since 1981, while in a further sign that the market is buying into the storyline of a soft landing, credit spreads have tightened not only for US High Yield and US IG-corporates but also for European IG-corporates.
The risk remained tilted to the upside with the global equity indices recording new highs. Momentum is still strong and we are now in an euphoric state. August is the weakest month for markets from a seasonal perspective, so we could see some softening from here.
As said last month (and the last few months too), we are positive on the higher-quality part of the fixed income asset class. History shows US government bond yields peaked not far from the peak in the Fed rate. Bond yields usually fall as growth slows, with longer-maturity bonds benefiting more; but we believe the asset class also pays an attractive yield for investors to wait. Cash yields undoubtedly appear optically interesting at this point in the cycle, but the headline yield fails to capture reinvestment risk, i.e., any cash deposit is likely to be reinvested at lower yields.
Another very interesting segment we took advantage since few months are the financial sector. For investors who agree that large bank risk has abated and who understand the risk of these instruments, Investment Grade preferred securities issued by banks yield about 7.20%.
Our view is that investor should focus on higher-quality corporate bonds, while we continue to keep our strong negative bias on High Yields. Also, some Emerging Market USD-denominated bonds are interesting: they may offer potentially strong risk diversification, but pay attention to their high idiosyncratic risk.
Next, we updated our monthly model portfolio, studying its performance and adding new bond ideas:
New ideas
Ideas reiterated and business case updates
Exits
The fixed income model portfolio includes Investment Grade and High Yield bonds.
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