Fed rates hike getting closer says GS’ Singer
Jason Singer (pictured), portfolio manager of the GS Global Strategic Income Bond Portfolio, comments on the prospects in fixed income and the potential for an increase in interest rates in Europe and the US.
What is the biggest risk facing fixed income investors today?
The US Federal Reserve is getting closer to raising rates. We think the biggest risk for fixed income investors is the timing of that change in policy. Ultimately, we think this will depend on inflation. Both the market and the Fed appear to believe that rates can remain low without sparking inflation, even with the economy improving. While we are not calling for a big increase in inflation, we think even a modest increase beyond what we have already seen could surprise both the market and the Fed. This could lead to a significant rethinking of how long the Fed can keep rates low without creating higher inflation.
But bond yields have fallen this year – should we still be positioning for a rising rate environment?
In our view, yes. Some of the decline in rates so far this year seems to have been driven by foreign central banks buying US government bonds, which caught other investors by surprise and led to further buying. However, the US and UK economies are both growing very well, with sharp declines in unemployment and broad improvement in economic indicators. As a result, both the Federal Reserve and the Bank of England are beginning to talk about rate hikes. In that environment, we think the risks are clearly tilted toward higher rather than lower rates in the bond market.
Which are the countries where government bonds can still offer good yield opportunities?
We currently see value in Latin American local rate markets, and have positioned the portfolio with longs in Brazil and Mexico. The market has priced significant risk premia into the long end of these curves, which we believe is not warranted by fundamentals. We are constructive on real (inflation-adjusted) interest rates in Brazil, which appear high relative to global peers. We expect Brazil’s real yields to converge to lower levels.
What are your expectations on EU rates?
We think rates in the Eurozone are near where they should be given the cross-currents in today’s environment. On one side, growth is improving in other major economies and that should generally put upward pressure on rates. However, on the other side, the Eurozone itself appears to be stuck in low gear, with slow growth and weak inflation. The European Central Bank could also begin buying bonds later this year or in 2015 with the goal of moving the economy into a higher gear. Considering the backdrop, we are neutral on the direction of rates in the Eurozone. That said, one of the benefits of our unconstrained approach in the GS Global Strategic Income Bond Portfolio is that we can run relative value strategies that could benefit if European government bonds outperform US government bonds, which is an area where we have much more conviction.
Are you exposed to Italy?
The portfolio currently has an exposure to Italian sovereign debt as a relative value position versus France. In Italy we believe political stability and a government with an ambitious reform agenda means that the prospects for structural reform have improved significantly. The supply / demand dynamics look positive and are being influenced by a primary fiscal surplus and increased buying from investors outside the region, notably Asia, searching for yield.
What is your strategy on corporate bonds?
We think US high yield corporate bonds are modestly attractive but we do not see much value in investment grade corporate bonds. Investment grade corporate bonds tend to move with government bonds, which means they are at risk if interest rates move higher. Investment grade corporate bonds also offer very little extra income compared to government bonds. On the other hand, the high yield market offers more income and could benefit from stronger growth simply because companies are less likely to default in an environment where the economy is growing well. However, we are somewhat cautious in high yield as the sector has already experienced a very strong rally and the market could become more turbulent if the Fed begins to signal rate hikes.
What is your outlook for the remainder of the year and how are you positioned?
At a high level, we’re positioned for higher government bond yields, dollar strength and modest spread tightening in High Yield corporates.
We are optimistic about economic growth in economies such as the US and UK, but less so in the Eurozone where the pace of recovery has been subdued. We think that US interest rates will rise in the coming quarters and we are running a negative duration position as a result. In recent years we were bullish on credit and benefited from this position, but high yield spreads look closer to fair value to us at present and as such we’ve decreased our position in high yield. Our currency positioning sees us long the US dollar versus other G10 currencies and long selective emerging market currencies such as the Indian rupee and Malaysian ringitt.