Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Chris Iggo, CIO Fixed Income Europe and Asia at AXA Investment Managers and Nick Hayes, manager of the AXA WF Global Strategic Bonds, comment on where market volatility has created value for fixed income investors.
Oil and Commodity Prices
The rapid decline in oil prices is coming to an end, but for many oil producers, for example in the shale market in the US and offshore oil fields, the current oil price is a problem. Lower prices are pushing commodity-reliant countries to devalue their currencies and Saudi Arabia recently announced that the current oil price has forced them to sell some foreign investments to cover a fund deficit.
Depending on at what level the oil price settles, the supply-and-demand dynamic in the industry is likely to shift. Some oil companies have cut back capital expenditure, which will restrict supply in the future and what’s happening with Glencore at the moment is a reflection of the broader commodities market.”
The declining oil price has also impacted high yield markets. High yield energy issuers are concentrated in North America and the emerging markets, so our current bond selection is prudent and seeks to avoid exposure to some of the more affected issuers. We favour nominal bonds over inflation-linked bonds given the outlook for inflation. The main concern for us now is where oil prices will settle, and it’s important for fixed income investors to lower their expectations of inflation given the chance that falling commodity prices will continue to impact the level of inflation.
Year to date we‘ve been decreasing the amount of high yield and emerging market debt exposure and have generally been more cautious or neutral in our decisions. We think we will see a rise in government bond yields once the current risk-off environment subsides. A bear market in credit has created opportunities for us – especially with the increase in the number of negative credit ‘events’ which means we can increase credit allocations at higher spreads and yields.
Federal Reserve Policy
The US interest rate increase didn’t happen in September. It’s difficult for market participants to accurately gauge the reaction function of the central banks, if we’re being cynical.
Looking ahead, I think the US economy will continue to prosper, which will periodically get people excited about the potential for a rate hike, but the global economic environment is likely to stay weak. The domestic US labour market is still very tight, but wages are picking up, as they are in the UK.
However, higher wages don’t immediately translate into inflation. Core inflation has so far stayed low, removing oil from the calculation. It’s difficult to have a view on one to two year inflation figures, but central banks will continue to set rates to reach inflation targets. What I would like to see is the Fed being more decisive - raise the rates and be confident about the state of the US economy.
Given the impending US rate rise risk and as the euro has begun to stabilise, we have started to position ourselves favourably in the Eurozone: overall, we prefer the Eurozone over US interest rate risk. Given attractive valuations, we have increased our allocation to investment grade corporate bonds, which has started to offer interesting yield levels for high quality credit.
This article is part of Morningstar's "Guide to Income Investing"
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