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The Iron Reign of Rates and Inflation

Report: Systematic Strategies

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Stockholm (HedgeNordic) – Fixed-income investors endured a challenging first part of 2022, but what does the second half of the year have in store for investors? According to Steven Oh, Global Head of Credit and Fixed Income at PineBridge Investments, “the path of inflation and the thrust of central bank moves to control it dominate the fixed income outlook for the second half of 2022.” Most notably, “the Federal Reserve’s aggressive shift toward tightening through both rate increases and balance sheet reduction.”

“These and other central banks’ steps to slow their economies have contributed to declines in fixed income asset classes amid stagflation fears,” explains Steven Oh in a mid-year fixed-income outlook. Stagflation fears “are understandable,” according to PineBridge’s Global Head of Credit and Fixed Income, but he and his team believe the fears “may be overblown given high levels of employment and a strong consumer and corporate balance sheets.”

“The path of inflation and the thrust of central bank moves to control it dominate the fixed income outlook for the second half of 2022.”

These challenges are exacerbated by major geopolitical risks, most notably the conflict in Ukraine and its implications for energy and food prices, as well as risk appetites across the credit spectrum. China’s lockdowns are also weighing on sentiment, argues Steven Oh, “though the Chinese government’s recent pivot to a ‘dynamic’ Covid policy could bring back a sense of normalcy and help support its economy.”

Key Trends in Global Fixed Income

Looking ahead to the rest of the year, Steven Oh and his team at PineBridge Investments see three key trends in the global fixed income sector of particular note: constructive on select segments of emerging market debt; high yield playing catchup with loans; and a widening of investment grade spreads in the near term.

“We see value opportunities emerging in the context of sovereign and sector driven risk events coupled with strong baseline corporate fundamentals,” Steven Oh elaborates on their constructive views on select segments of emerging market debt. “While assets have continued to trickle out of the EM bond market, we see no signs of panic,” says Oh. “We remain constructive over the long term given expectations of flat net issuance and continued new allocations to the asset class.”

Steven Oh and his team also expect the high-yield bond market to play catchup with loans. “Given the year-to-date moves in Treasury rates and the massive outperformance of loans vis-à-vis high yield, the weighted average price in the high yield market is significantly below that of the loan market,” points out Steven Oh. “While we see the potential for high yield spreads to continue to widen and overshoot on the downside, we believe this differential in terms of the average discount to par will eventually provide a tailwind.”

“Though an imminent recession is not our base case, the downside risks in this market call for continued defensive positioning.”

Although all-in yields remain attractive to investors, Steven Oh and his team at PineBridge Investments believe spreads will continue to widen in the near term. “As a longer-duration fixed income asset class, investment grade credit has been hit hard by the Fed’s aggressive policy stance and the backup in rates thus far, with spreads widening substantially,” explains Steven Oh. He goes on to say that “though an imminent recession is not our base case, the downside risks in this market call for continued defensive positioning.” The economy is strong but showing some signs of weakness. For this reason, “rallies should be viewed as an opportunity to further reduce risk and to build up more dry powder in anticipation of an eventual Fed pivot – at which point investors may want to be ready to take on risk.”

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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