Global fixed income and how it relates to markets

Connie Queline

Global fixed income and how it relates to markets

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JIMMY MOYAHA: The year 2024 has started off much like 2023, with a need for finding valuable investment opportunities, particularly in the climate we find ourselves in.

I’m joined on the line by portfolio manager at Ninety One, Paul Carr, to take a look at some unique opportunities that might be available for investors seeking diversified income streams and stable income streams – especially with all of the developments that are happening around the world.

Good evening, Paul. Thanks so much for taking the time. I suppose let’s start with where we stand on the outlook for products like fixed-income products – especially at a global level with interest rates around the world having very different conversations unfolding from what we thought we’d be seeing at the start of the year.

PAUL CARR: Yes. Hi, Jimmy. Thanks for having me on today. It’s really interesting.

We very much think that with interest rates close to 17-year highs – in particular in the US – it is an attractive opportunity for investors to generally benefit from this generous yield environment that’s currently out there; in particular I think at the moment, because there’s very much a consensus view that the interest rate cycle currently has peaked and expectations are that interest rates are coming down.

And in some respects earlier in the year there are expectations for those interest rates to come down quite rapidly. But that’s been pared back a little.

Ultimately we think inflation will be that key driver for rate cuts this year, rather than a much weaker growth outlook. So we think it’s really attractive for relatively conservative investors who want to pick up attractive cash-plus-income over and above very conservative US dollar cash at the moment.

JIMMY MOYAHA: Paul, you mentioned that we anticipate that rates have peaked, but the uncertainty still remains around the aggressiveness with which the rate cuts will take place. Does this mean then that investors who are yield-hungry at this stage would have a bit more runway to get in some last-minute yields, or are investors starting to see it as a slowdown in the cycle, and maybe looking to see when they start to pull out of things like fixed income?

PAUL CARR: Yes, it’s a good question. We don’t think that it’s too soon at all to pull out. Ultimately we think the rate-cutting cycle really looks too aggressive at the moment. There’s a lot of uncertainty, actually, as we go through this year, about when the first rate cut may even materialise – and it keeps getting pushed out.

When we look into it with a little more detail, we understand that the Federal Reserve forecasts just three 25 basis point cuts for 2024, and then the markets pared back those expectations to close to four cuts for this year.

We actually at the moment think that’s a little bit too much in itself.

We think somewhere close to three rate cuts this year may be realistic.

With growth looking as strong as it has, there may be a risk that we get just two cuts this year. But at the moment we think three rate cuts is probably a relatively good outcome for this year which, given absolute levels of cash, currently above US dollar cash – just looks an attractive environment for fixed-income investors.

JIMMY MOYAHA: Paul, let’s dig a little more into those rate cuts and that forecast. We’ve got an FOMC [Federal Open Market Committee] meeting coming out tomorrow, on Wednesday [28 February, that is] – and at that meeting we are obviously expecting a lot more guidance around what the Fed’s position is on these rate cuts.

We’ve already touched on the fact that we’re not likely to see much aggression in the rate-cutting cycle. Have we got a timing from the cut perspective on that? Do we anticipate that this is now Q3 or Q4? I know when we initially came into 2024, we had outlined at least one cut by the start of Q2, and at the moment that looks like it is not happening at all. Where do we see the timings coming through with these rate cuts, and how will those timings then influence what conservative investors – or even yield-hungry investors – might be thinking at this stage?

PAUL CARR: Absolutely. We came into the year with quite a dovish outcome, and I think that was pretty much guided by the Fed in that peak policy rates really mean that the next step within a couple of quarters, or certainly the first quarter, meant that rates were coming down – and the market very much homed in on March being the first potential rate cut.

But since then we’ve really had stronger growth and I think that’s going to be critical to the initial starting point of that cutting cycle.

We’ve had quite strong labour markets – very strong, actually – when you look at the relative data.

But also as central banks have really highlighted that last stage of getting inflation down as the most critical.

I think that central banks really don’t want to ease off tight policy until they’ve seen that inflation coming down in line with their targets.

And the most recent couple of prints – in particular from the United States – have been a little bit sticky. When you’re looking [and] it’s coming down, we get disinflation; but that last little leg is proving quite tough.

So I think a combination of this inflation normalisation [and] the strong growth means that the rate-cutting cycle just continually gets pushed out. I think ultimately it may be something we have to think about in the second half of the year, rather than anything happening in the first half of the year.

As I said, if growth doesn’t come down as quickly as expected and actually surprises to the upside, it could even get pushed into the fourth quarter this year.

But ultimately, what I think is important is that growth remains firm so you get a generous income as a conservative investor.

But for portfolios like the Global Diversified Income portfolio that we run at Ninety One, it’s very much focused on attractive cash plus returns. And in a strong growth environment it really does support portfolios like that – that you have an income, an element of ‘cash plus credit’ within those portfolios.

JIMMY MOYAHA: Paul, we looked at America. I want to look at a couple of other geographical preferences that you might have. I know that we are looking at regions like the UK and Japan as ‘other’ developed markets – but in both cases just last week it seems we’ve gone into a technical recession on both fronts. Is that having an impact on how investors are seeing things from a growth perspective because you just mentioned that with prospects, and looking forward towards these things, the income part of it is one component, but growth and inflation management is a whole other conversation still happening. Is this affecting how you are viewing things like UK bonds or possibly even Japanese bonds?

PAUL CARR: Absolutely. We are very much focused on investing the portfolio across the entirety of the developed-market universe. I think that allows us to take opportunities in countries where we see the outlook being much more favourable for fixed-income assets.

And the UK, as you mentioned, is exactly one of those markets that we think is much more favourable for fixed-income assets.

The Bank of England has raised interest rates quite significantly and, as you mentioned, we’ve had a technical recession in the UK now, with growth remaining very, very weak. We think ultimately the growth outlook in the UK stabilises to some extent, but that does mean I think that growth remains relatively weak, but inflation has been coming down. Those combinations just mean that we believe having that little bit of exposure in the portfolio to UK bonds really diversifies the return stream for our underlying investors. So we think the UK is quite attractive, as well.

And interestingly, the market in Japan, for example, has been very much focused on normalisation of interest rate policy in Japan. To some extent it’s being delayed because growth has been somewhat surprisin; a little bit lower than expected in Japan.

But also inflation – they’ve structurally been waiting for a turnaround in inflation in Japan for many years. This has gradually been occurring, but it’s been occurring a lot slower than investors have been expecting.

So we think there are opportunities to take advantage of this by being underweight the Japanese yen, for example, within the portfolio.

It has quite a negative correlation with bonds, but ultimately having some exposure to short Japanese yen in the portfolio again offers some smoother return profile to the underlying returns and diversification – where we see those opportunities.

JIMMY MOYAHA: Paul, you touched on the Global Diversified Income Fund. I wonder if I could pick your brain around this. Where do you see emerging-market bonds fitting into a portfolio like that? Given that we are starting to see that emerging markets are coming back into the fold as somewhat of an attractive destination, are you still seeing risk within emerging markets as elevated? Or is it now starting to look like something you could say we could probably dip into in the portfolio?

PAUL CARR: Absolutely. Certainly for this portfolio we look at emerging-market bonds and emerging-market credit. It’s not the core component of this portfolio, but we think ultimately emerging markets offer that – diversifying risk-adjusted returns for portfolios. So they make a very attractive investment case where you have them in your portfolio and your risk alternative.

So we have some exposure to emerging markets in this portfolio, but predominantly this portfolio [comprises] developed markets, ultimately trying to earn cash-plus returns or US dollar cash-plus returns for conservative investors.

And we think emerging markets offer the risk-adjusted returns that fit within that profile, but we have only a small allocation within our portfolio.

Ultimately, with volatility actually being a lot higher in developed markets relative to emerging markets, emerging markets offer that diversified portfolio return stream that just makes for more diversified returns as we move forward.

JIMMY MOYAHA: I suppose this is the unique benefit of having such a global footprint as Ninety One does.

We’ll leave the conversation at that. Thanks so much, Paul. That was Paul Carr, who is portfolio manager at Ninety One, sharing his thoughts around their latest or their existing portfolio offering – the Global Diversified Income Fund – but also his outlook on emerging markets and developed markets where it relates to fixed income.

Brought to you by Ninety One.

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