The dichotomy between views from interest rate managers and credit managers continues. In our latest fixed income survey1, rates managers have blinked first.

This quarter’s survey closed right before the February market sell-off, thus managers did not have the benefit of hindsight with regards to market repricing. Nonetheless, the results continue to provide valuable insight.

Previously, we have highlighted the dichotomy between views from interest rate managers and credit managers, with rates managers implying low growth and low inflation while credit managers expected improving corporate fundamentals.This was contradictory over the long run as it is difficult to both expect low growth and strong credit fundamentals indefinitely.

In this survey rates managers have blinked first and are adjusting their views.Managers are forming a consensus on higher rates: the federal funds rate peak forecast came in 40 basis points (bps) higher than the previous survey and expectations for the 10-year U.S. Treasury yield showed a build of managers expecting it to be 2.8% or higher, which subsequent to the survey has materialized.

The question now is whether these higher rates that are expected will ultimately also impact credit market fundamentals.

According to this survey, the answer is no. Participants are favouring high-yield credit again on the back of perceived improvement in fundamentals, but managers express caution with investment grade credit. Amongst credit markets, managers favor non-agency mortgages most in terms of spread tightening.

The clear bull among fixed income subsectors remains local emerging market debt.More managers favor local emerging market debt than in our last survey, in spite of the strong performance already posted by this sector.

Finally, the U.S. dollar (USD) is perceived to be in a continued weakening phase, which also serves as a tailwind to emerging market currencies.However, if the U.S. Federal Reserve (the Fed) delivers on three or more rate hikes—which 85% of interest rate managers expect—a legitimate question becomes whether this weakness will continue, and what impact might it have on local currency emerging market debt?

Key findings from our Q1 survey:

  • Federal funds rate forecasted to peak 40bps higher
  • The 10-year U.S. Treasury yield is expected to be 2.8% or higher (which has already materialized subsequent to this survey)
  • These higher rates are not expected to impact credit markets
  • High-yield credit is favored again, on the back of perceived improvement in fundamentals
  • Surveyed managers expressed caution with investment-grade credit
  • Amongst credit markets, non-agency mortgages have the highest skew towards predicted spread-tightening
  • Local emerging-market debt continues to be the clear bull among fixed-income subsectors
  • The U.S. dollar is perceived to be in a continued weakening phase, creating a tailwind for emerging-market currencies
  • In our Q1 2018 survey, we received answers from 70 different fixed-income investment firms across the world, with specialist teams at each of these firms assigned to provide answers for their respective subsectors. Bond and currency managers in eight specialised areas were asked to consider valuations, expectations and outlooks for the coming months.

    Today, we’ve chosen to focus on the conclusions drawn for credit, interest rates, emerging market bonds, currencies, securitized bonds and municipal bonds.

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