23 April 2020
At GAM Investments’ Weekly Fixed Income meeting held on 21 April, a group of our portfolio managers discussed their views on current market conditions.
Markus Heider – Emerging Market Bonds
For emerging markets (EM) to do well, global markets require a growth rebound in Q3 or Q4. At a minimum, we would hope to see a peak in fatalities and new daily cases of the virus, followed by a clear downtrend in the month of May. This may allow for some form of normalisation by Q3. At the present moment, Europe now seems to be on a downtrend, with Germany, France and Spain recovering at faster rates than Italy. This looks like we are on a trajectory that would allow governments to start to lift containment measures from May; however, this would be a best case scenario.
Another condition for an effective EM recovery has been a strong economic policy response. Interest rates are being cut across the world, except in places where rates were already at zero. We have seen fiscal policy effects too, which has been important in bringing support to economies during the time of the lockdown.
Casey Goldmann and Jack Flaherty – US Credit
Higher quality high yield (HY) bonds have rallied along with liquid exchange-traded fund (ETF) names, helped by support from the Federal Reserve (Fed). Even so, prices have not yet fully recovered. Illiquid, lower quality names in particular are still lagging. We have seen a large number of bonds move from investment grade (IG) to HY. There has also been a significant amount of IG new issuance to increase companies' liquidity. Many companies still have a risk of becoming ‘fallen angels’ – ratings agencies are waiting to see the full effect of the shutdown and much depends on whether agencies look past the ' valley' and across for a recovery.
We have seen huge price bifurcation in many sectors, notably energy. Lower quality names are trading at levels as low as a few cents on the dollar while higher quality energy names are holding up well. In our view, smaller US shale companies will find it difficult to survive this period and we foresee bankruptcies and consolidation occurring. Not only do shale gas wells require significant investment, restart costs alone can result in wells being abandoned. For many US producers, the current oil price environment is debilitating and ultimately there is nothing President Trump can do to meaningfully alter the situation. That said, assuming the world returns to some level of normality in a year, we foresee an oil price bounce further down the road.
Alex McKnight – Global Credit
We feel the oil price decline seen in the May contract is not a one-off event and would expect the same to happen to the June contract and possibly beyond. This cannot change until supply reduces and restrictions are lifted, leading to some return to a new normality. The inflationary impact is going to be very interesting – this move in oil prices is deflationary in the near term, but likely inflationary (due to perhaps permanent supply reductions) in the long term.
Markets possibly became overly optimistic last week, and we are seeing a risk sell off so far this week. While some of that is due to the shock of the oil price crash, the rest can likely be attributed to the realisation coming upon all market participants that a return to normal will not be like “normal” as we know it.
Adrian Owens – Global Rates
The latest fall in oil prices has resulted in the market pricing lower US 10 year break-even inflation rates. US 10 year break-evens, as priced by Tips, are back below 1% (having recently bounced from a low of around 0.5%). Investors are pricing lower inflation in the coming months, but longer-term concerns over how authorities will deal with ever growing levels of debt have resulted in higher inflation expectations further along the curve. The spread between 5 and 30 year breakeven inflation has widened from less than 20 bps pre-crisis to around 85 bps (priced off swaps).
The Norwegian krone has weakened on the back of the latest falls in oil prices, but there are signs that its sensitivity to oil is diminishing. At the time of writing, the EUR/NOK cross is trading at similar levels to the start of the month despite further oil price falls. Mexico has been hit by the oil price and, together with Pemex, a credit downgrade by Moody’s. That said, the downgrade was widely expected and with 30 year bonds trading above 8% and short-term interest rates likely to be cut, we believe that owning bonds un-hedged remains an attractive investment.
On a final point, the Canadian bond market has underperformed many markets, particularly the UK; however, Canada is facing many headwinds, most notably collapsing oil prices and an overleveraged consumer. With the economic outlook deteriorating, we believe the bond market looks attractive on a relative basis.
Tom Mansley – Mortgage-Backed Securities
The MBS market has been relatively stable although the subordinated debt slices of commercial mortgage-backed securities (CMBS) are still taking a hit. AAA-rated bonds have bounced back although the same cannot be said for BBBs, particularly in the hospitality and retail sectors.
Residential mortgage-backed securities (RMBS) look to be in better shape. The US now has in excess of 22 million unemployed, although this is likely to be a short-term problem among what is a 170 million strong workforce. Tools, such as forbearance and loan modifications, will help people get through this crisis. The RMBS market should not be significantly impacted, in our view.
Source: GAM unless otherwise stated. The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. Reference to a security is not a recommendation to buy or sell that security. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. April 2020.