At GAM Investments’ latest Fixed Income Meeting, held on 23 February, three of our investment experts discussed the recent winter storms in Texas, the outlook on inflation and the steepening of yield curves.
Jack Flaherty – US Credit
The utilities sector is at the forefront of our minds after the recent catastrophic storms in Texas. The sector’s general business model tends to be highly leveraged and therefore requires some stability of income for it to make sense. The significant weather disruption has made the lack of investment in infrastructure in the US painfully obvious; the recent power cuts have wreaked havoc on the lives of Texans, not dissimilar to the impact of the wildfires in California last year. Most importantly, these disasters could have been avoided had warnings been heeded by the state regulatory bodies. The US government continues to talk about a ‘bipartisan’ agreement for infrastructure, however we continue to see a lack of any real action taking place.
Over the past week, the high yield (HY) bond market has held up well, despite US rates continuing to move higher – with both spreads and total returns close to unchanged. The energy sector continues to perform well however we are wary of the general market reaction to higher prices which seems to be a prediction of yet further price rises. In general, there has been a rotation towards commodities, although not quite as pronounced as that in the equity market.
Rahul Mathur – Global Rates
One of the challenges at the moment is around the timing of playing the reflation theme. Real and nominal yields have moved higher, with break evens moving modestly lower over the last few weeks. On the face of it, this could suggest central banks have reverted to their pre-Covid-19 modus operandi (MO) – pre-emptive tightening before inflation reaches target; an environment in which inflation will not be allowed to overshoot. However we do not think this is the case. Central banks, including the Federal Reserve (Fed), have been explicit in their adoption of average inflation targeting regimes, indicating they are happy to allow inflation to overshoot. On top of this, given the extensive fiscal expansion that is taking place, we think there is still significant political impetus to generate inflation in order to erode the value of real debt.
In the prepared statement for his semi-annual testimony this week, Governor Jerome Powell, Chair of the Fed, emphasised his view that taper talk is premature, and demonstrated the Fed’s intention is to keep rates near zero until full employment and inflation rises to 2%, and is on track to moderately exceed 2% for some time. With 10-year or 30-year US inflation break evens at around 2.2%-2.3%, expected inflation seems under-priced in an historical context, given that average inflation over the last 30 years has averaged 2.5% per annum. We are still seeing the inflationary effects of supply chain disruption, which is idiosyncratic to this shock. Most significantly this is apparent when looking at base metals and international freight rates, which have continued to perform strongly, despite the softer risk tone over the last week.
Florian Komac – European Credit
In the eurozone there has been a steepening of yield curves; German bunds yield rose from -0.5% a month ago to -0.3% in 10-year break evens and are up 27 bps for the year. This is in contrast to statements released by the European Central Bank (ECB) which stated its inflationary outlook is not consistent with higher yields at the long end of the curve, but it was clearly noted it continues to closely monitor long-term yields. Credit spreads, both in high yield (HY) and investment grade (IG), are generally sideways and therefore not displaying the nervous sentiment that is returning to equity markets. In our view, this will most likely be short lived and the start of a more sideways trading range, given that relative value (RV) opportunities (most especially in IG) are few and far between.
At the periphery, Italian spreads are finally steepening. The newly elected Italian prime minister, Mario Draghi, won his first confidence votes in the Senate, which is an encouraging sign that stability may be returning to the country. Finally, something that has stood out to us on a company note was HSBC’s recent announcement of an acceleration of its ‘pivot to Asia’ strategy. HSBC has decided to move key people to Hong Kong and Singapore and close its retail businesses in the US and France, making one wonder how the equivalence rules between the EU and the UK Investment Association, if and when they are agreed upon, will influence the financial sector.
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