We anticipate periods of heightened volatility for world bond markets throughout 2017, so it will be a year where it will be necessary to alter strategy several times on changing policy and economic signals.
With the expectation of gradual shift in global monetary policy on the back of normalising inflation and an improving economic outlook, we anticipate remaining underweight government debt and overweight spread sectors over the coming months.
Here are the top five trades within our Neuberger Berman Global Bond Absolute Return Fund:
Non-agency RMBS remains one of our highest conviction overweights. The asset class maintains a very low correlation to risk free rates and risky assets, while still offering an attractive projected loss-adjusted yield. Fundamentals continue to improve as lower and more stable oil prices help households with their balance sheets and as consumer confidence recovers. Scarcity value in the asset class remains to be a positive technical factor as search for yield environment persists and we expect fundamentals to continue to improve with recovering US real estate market and stronger consumer balance sheets.
European High Yield
The European high yield sector continues to benefit from limited commodity exposure and lesser sensitivity to changes in US monetary policy while at the same time being technically well supported by the European Central Bank’s investment grade corporate bond purchases – depressing yields and spreads beyond the target universe. Projected default rates remain subdued, which in relation to improving fundamentals maintains the attractiveness of the risk premium offered by European high yield credit spreads. That said, we maintain reduced credit sector exposures, including in Europe, since valuations are at their recent tights, and volatility may emerge from the monetary policy surprises and political risk on the horizon.
30-Year Government Bond Spread – US vs Germany
The fund continues to hold a position representing ~2 years of duration contribution in a 30-year government bond spread trade between the US and Germany and a further ~1 year of duration contribution through 10 year part of the curve. The 30 year spread continues to range in 190 basis points area, having moved in the 170-230 basis points range over the final quarter 2017. We continue to assess these levels as substantially dislocated as the growth rate differential between the two economies implied by this spread cannot be sustained in the long run. We believe signs of this are firmly emerging – whether in a form of improving economic data across continents or changing monetary policy assessment by the respective central banks. Until the spread converges, this position should continue to provide for attractive carry uplift to the portfolio.
The portfolio continues to have negative headline duration on the fund level as we continue to see more opportunities in the reflationary stories across developed markets. Historically low sovereign bond yields faced by investors today cannot be sustained indefinitely amidst improved economic outlook, rising inflation and continuously improving labour market situation. Inflation expectations have further to recover should fiscal agendas be followed through and US yield curve continues to reflect milder pace of hiking cycle than indicated by US Federal Reserve. We believe this extremely gradual pace for hikes priced by markets is a low bar to exceed, even if the path of hikes is slow as we expect.
Inflation Linked Bonds
We also continue to hold US TIPS as we believe the US economy will reflate beyond recent trend growth, but fall short of pre-crisis levels. Inflation will likely move toward the Fed’s 2% target rate and maybe even run a little bit hotter than that. Real interest rates in the US have headed higher following the election, and we believe the bias for rates remains higher over the coming 12 months due to three factors: higher economic growth expectations, higher inflation expectations and an increase in risk premia.
Jon Jonsson is manager of the Neuberger Berman Global Bond Absolute Return Fund