Market update - Fixed Income

fedescolari (58)in #money • 6 years ago (edited)

Dear friends,

Today I gave a speech about an update on the situation in financial (FIAT) markets

n1 - the flattening of the yield curve

As you can see from the chart below, the spread between the 2 and 10yrs treasury has now almost reached my near term 40bps target.
The last 4 weeks saw a strong acceleration of this curve flattening, in fact we are now at the flattest levels since 10years.

Source: My Bloomberg Terminal

This recent flattening move can be mostly explained by the rise in short dated yields, which, for example the 2 years US Treasury yield moved up from 2.3% to 2.47%, mainly to re-pricing of Federal Reserve hiking expectations and risk-on in Equity markets, see graph where you can see this correlation

Source: My Bloomberg Terminal

n2 what is being expected by the market

So what is being priced on the US curve, what is already expected by the market.
Well, if we look at the chart below, this Bloomberg chart shows how many percentage points of Fed hikes are priced-in (hence expected) by the market for the next 12 months. And as you can see, 2 hikes of 25bps are already in the price, this is important and can be helpful in understanding why you should not be scared to invest in Fixed Income today: Federal Reserve is in full hiking mode, but the market already expects it.
In fact, it is worth mentioning that the risk that something would interrupt the Fed’s plans to continue hiking is not in the price, hence the risk seems to be skewed towards lower yields, not higher.

Source: My Bloomberg Terminal

In this backdrop I believe a duration barbell strategy works well, either by combining short duration High Yield bonds with long duration Investment Grade, or by complementing long duration Investment Grade and neutralize duration risk with some floating coupon bonds.

n3 Credit spreads in Emerging Markets (EM) and in the US, still like EM

Since the news on sanctions on Russia broke out, Russian credit spreads spiked about 95bps (see chart below) and now seem to be stabilized, creating some opportunities. On the other hand though, I have noticed that the investors’ sentiment in other EM regions remained rather complacent, in fact since the 6th of April spreads mostly tightened across the EM space, namely in Indonesia, Argentina and Brazil.
And not only in EM, in fact US HY spreads tightened aggressively, as per the chart below, you can see that US HY spreads are back to the tights witnessed at the end of January. It is possible to see further evidence of such move, from the very strong inflows that HY bond funds experienced during last week, which was in fact the biggest HY fund inflow week since January.

Source: My Bloomberg Terminal

Stay connected,

Markets are moving, something is cooking, remain invested as growth is still the story, hopefully will continue this Bull market since the last 10 years

bests,