Fixed income: No alternative to riskier segments

Alejandro Hardziej, Fixed Income analyst at Julius Baer, comments on how fundamentals alone do not justify the strong performance in US high-yield and emerging market bonds this year.

The hunt for yield in the riskier fixed income segments is becoming a repetitive theme by now, but bond investors simply have no alternative to emerging market (EM) and US high-yield (HY) bonds when looking for reasonable yields above zero.

The fundamental picture in the risky segments is improving but not at the pace of valuations. Oil hovering around €45 is high enough to sustain the business of many oil producers, and the partial recovery of some metal commodities has dissipated near-term default concerns in the mining space.

Similarly, the general appreciation of emerging market currencies is an important tailwind for EM issuers, in particular for those with a domestic focus. However, such improvements alone cannot justify the 14% return in both, US and EM high-yield bonds.

Is this the end of the rally for these segments? Not necessarily.

Inflows into these segments will remain strong as long as the fixed income market remains distorted by low interest rate policies in the developed world. With no signs of higher rates in the UK, Europe or Japan anytime soon, and given the stability in global growth and commodities, investors will likely continue to focus on absolute yields.

Thus, emerging market and US high-yield bonds remain our preferred segments, but our view is driven by inflows momentum rather than by the fundamental outlook.


Source: Bank of America Merrill Lynch, JP Morgan, Julius Baer



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