By Vineet Naik.
State Street Global Advisors (SSGA) is predicting that US Treasuries, convertible bonds and emerging market (EM) debt will see increased investment in 2019, with downward pressure on economic growth and potential downturns on the horizon. In its ‘Bond Compass Q1 2019’, SSGA based its insights into the global fixed income market using a snapshot of fixed income flows and holdings indicators, derived from a data set that represents US$10 trillion of assets.
State Street’s investment outlook for Q1 2019 identifies three broad themes and how to navigate them. The first theme is that inflation will keep pressure on yield, and that economic growth will likely slow in 2019. SSGA recommends a bias towards the more stable shorter duration bonds while this interest rate normalisation policy is in play, with the long end more susceptible to market dynamics. They also recommend a move upwards in quality, considering the contrast in changes to yield spread. For example, investment grade European bond spreads only moved 65 bps to 1.52% in 2018, compared to a 221 bps widening of high yield. The report suggests that one way to navigate the fluid European situation is to increase US Treasury exposures.
The investment firm found that institutional investors have been selling Treasuries across the curve despite Treasuries having experienced their best quarterly returns in three years in the last quarter of the year, indicating that investors do not expect Q4’s gains to be repeated. Another key finding was that despite weak demand in Q4, in December at least, investors began to increase allocations to riskier sovereign bonds such as Italian and emerging market debt. This does not mean that populist politics as a market theme is over, however, with European parliamentary elections in May set to play a key role.
SSGA notes that investing in convertibles could work as a buffer against potential downturns in 2019, which would also allow the owner to participate in equity rallies. Convertibles would also have less interest rate sensitivity because of the equity option. It may be appealing to quickly gain exposure to convertibles by investing in exchange-traded funds (ETFs).
The International Monetary Fund is forecasting a gross domestic product growth rate of 4.7% across EM in contrast with developed markets (DM) which are forecast to slow down from 2.4% to 2.1% in 2019. Inflation is also expected to stabilise in emerging markets. Some tightening of central bank policy may be in store for EM economies, however the effect on local currency bonds will be limited due to preemptive hikes that have already taken place to anchor inflation. EM ETFs have an average yield of 5.9%, and SSGA argues that exposure to EM debt is more viable now due to much greater diversity and liquidity. As a result of these factors, State Street say they may offer a better trade-off than their DM counterparts.
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