Global fixed income hangs in US/China trade balance

Global fixed interest markets had a rocky 2018, driven by the US Federal Reserve hiking cash rates and the US/China trade war, and while January saw the asset class rally, a positive turn in global politics could see the asset class soar further. 

Real Asset Management’s Michael Frearson says the increased risks to global trade and fears over the pace of US Fed interest rate tightening weighed on markets last quarter, and global growth has clearly slowed while, simultaneously, the volatility of the fixed interest market spiked. 

Despite the uninviting market, investors found some solace in high-quality sovereign debt, which rallied during this period. Credit spreads similarly spiked, particularly in the lower quality high-yield segment, according to Frearson. 

Trade issues have flowed through to material changes in the near-term outlook for global growth, he says, and its impacting both developed and developing economies, with rapid downgrades in outlooks taking place in central banks and the IMF.

Data from FE Analytics shows the Fixed Interest – Global Bond sector has returned 3.12 per cent for the year to last month’s end, 3.47 per cent for the three years to last month’s end, and 3.53 per cent for the five years to the same date. 

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Chart 1: The performance of the top global bond fund as compared to the fixed interest – global bond sector average for the three years to date.

Taking it to a fund level, the CFS High Quality US High Yield fund was the top performing fund for the year to last month’s end, returning 14.47 per cent in that period. It was followed by the CFS US Short Duration High Yield fund and the CFS US Select High Yield fund, which returned 14.27 per cent and 14.01 per cent respectively. 

Whilst the top funds had a bias towards the US, the Colchester Emerging Markets Bond fund, which aims to generate income by investing in government bonds and currencies in emerging markets, also sat in the top 10 funds for the 12 months to last month’s end.

This particular fund had a bias towards Latin America, with Mexico, Colombia and Brazil featuring heavily in its top 10, followed by securities in Thailand, Malaysia, South Africa and Russia.

The outlook for 2019

Going forward, Frearson expects that, given the flow of economic data increasingly highlighting a global slow down, the rally in risk assets will pause in the coming months as investors re-assess the outlook for growth and inflation. 

“Credit markets have rallied strongly during January on speculation the trade negotiations are going well, while sovereign yields have remained relatively stable,” he said. 

But, should a trade agreement be reached without negatively impacting global growth during 2019, Frearson said there is room for credit securities to rally further.

Turning away from the US and China and towards Europe, the economic outlook there is similarly weak with the uncertainty around Brexit continuing. 

“Markets will continue to be impacted by qualitative tightening which is likely to increase volatility,” he said. “We remain cautious about the medium-term global outlook expecting volatility to return to more normal levels after [over] five years of benign market volatility across all asset classes.”

Domestically, the sovereign yield curve appears to have rallied too far in the short-term, and Frearson expects ten-year bond yields to drive back towards a 2.3 per cent to 2.5 per cent range. 

Fixed income sweet spots 

According to Frearson, a weak December for credit sectors has provided a valuation opportunity, even post the 2019 rally in credit spreads, but he advises investors to carefully select their securities given the outlook for slowing global growth. 

“We are seeing attractive opportunities in global USD capital securities as well as domestic markets,” he said. “This is particularly evident in the Australian bank capital securities markets with major banks recently issuing longer-dated capital notes at 4.0 per cent plus gross margins.”

Frearson said the high-quality end of the Australian securitisation market also appeared to offer value after some slight credit spread widening last year, but he was cautious on the outlook for domestic sovereign bonds given the strong rally over recent months.