By Russell Investments: Russell Investments’ latest survey of fixed income managers reveals a majority (55%) expects U.S. inflation to track between 2.26% and 2.75% for the next 12 months, while 20% see it moving above this range. The global survey also revealed a shift in views on timing for the first increase for the U.S. Federal Reserve funds rate. Fifty percent of survey respondents now expect the Fed to make its move in the second half of 2022, versus 80% in the Q2 survey who said they didn’t expect the Fed to begin lifting rates until 2023.
“Inflation proved to have a bigger bite than previously thought, forcing managers to consider the prospect of earlier interest rate rises,” said Adam Smears, Head of Fixed Income Research at Russell Investments. “However, our survey indicates fixed income managers believe inflation will stay roughly under control in the long term and inflation effects will be transitory. Time will tell if managers have this correct.”
“Inflation proved to have a bigger bite than previously thought, forcing managers to consider the prospect of earlier interest rate rises.”
The 53 bond and currency managers who responded to Russell Investments’ Q4 2021 survey also revealed the following views:
U.S. Yield Curve
35% of survey respondents expect a bear steepening of the yield curve in the next 12 months, while 45% expect a bear flattening. “Managers expect movement in the U.S. yield curve but disagree on which end of the curve the impact will be more significant,” Smears said. In addition, 42% of respondents expect the 10-year U.S. Treasury to trade between 1.61% and 2% in the next 12 months, with another 42% expecting rates to trade above 2% in the year ahead. Views are considerably more spread out now versus the last survey in June, when 72% of managers expected 10-year U.S. Treasury to trade in the narrower range of 1.80% to 2.2%.
30% of respondents expect a moderate widening in spreads over the next 12 months, while 60% still see range-bound spreads. In addition, 52% expect the pace of deleveraging to slow down, dropping from 69% in the Q2 survey. Meanwhile, the percentage who believe current spreads compensate for potential risks of deteriorating credit quality declined from the last survey, and the percentage who believe that caution should be warranted due to current spreads and leverage expectations also decreased. Among regions, Europe (ex-UK) replaced the U.S. as the most attractive for returns.
80% of managers expect range-bound spreads over the next 12 months. While no respondent expects a tightening of spreads, 20% anticipate a moderate widening. In addition, survey respondents remain constructive on fundamentals: 25% expect material improvement in corporate fundamentals and 60% expect some modest improvement. Accordingly, the survey found reduced expectation for rising defaults as 95% of managers see defaults below their long-term average of 3% (up from 78% in Q2). Among asset classes, leverage loans ranked as the favoured asset class in the last survey, but they are now ranked equally with both mezzanine collateralised loan obligations and high-yield emerging market bonds. Regarding potential risks, respondents see inflation, rising interest rates and slowing Chinese growth as the most concerning.
Emerging Market (EM) Debt – Local Currency
Managers indicate slightly more concern for EM FX as the percentage with positive views declined to 62% this quarter from 71% in Q2. Furthermore, the weighted expected return for next year has fallen from 5.6% to 3.5%. Among specific currencies, managers expect the Russian ruble, Brazilian real and the Egyptian pound to be the best-performing currencies in the next 12 months, while 32% of managers expect the Turkish lira to be the worst-performing currency.
Emerging Market Debt – Hard Currency
Only 29% of respondents expect spreads in the HC EMD index to tighten in the next 12 months, versus 33% in the Q2 survey, while 17% of managers expect spreads to widen. Regarding specific currencies, respondents listed Egypt, Ukraine and Mexico as the countries with the highest expected return over the next 12 months. China and the Philippines again ranked as the least attractive.
63% of respondents expect the U.S. dollar to gain value versus the euro and to trade below the current 1.16 EUR/USD exchange rate. About 80% of managers expected the pair to trade in the 1.21/1.30 range in the Q2 survey.
The proportion of respondents seeking to reduce securitised risk declined from the last survey, while the proportion seeking to maintain or add, slightly rose. BBB collateralised-loan obligations ranks as the most preferred securitised segment, followed closely by BBB- commercial mortgage-backed securities. Preference for residential mortgage exposure, which had ranked the highest, modestly declined. In addition, 50% of managers expect non-agency spreads to moderately tighten in the next 12 months. Moreover, 31% of respondents expect spreads to range bound. Managers also expressed more balanced views regarding concerns for the CLO market with 69% mentioning broad risk-off market sentiment as main the risk, followed by underlying loan collateral credit deterioration.
This article features in HedgeNordic’s 2021 “Alternative Fixed Income” publication.