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The age of low yields is not yet over—even though policymakers strive to return to a normal environment, says Gareth Colesmith, head of global rates and macro research, Insight. On the positive side of the ledger, rising vaccination rates—bolstered by booster shots—have allowed most developed markets economies to reopen, with economic activity bouncing back as a result.
In some countries, such as the US and China, the economic recovery is now at an advanced stage, with activity back to, or even above, pre-pandemic trends. Less positive, according to Colesmith, is how the rapid recovery has outpaced the rate at which supply chains could reopen, which in turn has squeezed prices upward in certain sectors, compounded by elevated shipping costs and soaring commodity prices.
The result is accelerating inflation, the fraying nerves of central bankers, and policy normalization pursued with varying degrees of urgency.
“In some emerging markets,” Colesmith says, “the hiking cycle [of interest rates] has already started, with some central banks prioritizing inflationary concerns over economic fundamentals. In developed markets, bond-purchase programs are being brought to a close, and in some markets, the timing of interest-rate hikes is now an active point of discussion.” Together, these variations in the future fiscal impulse complicate the economic outlook.
In the US, the unprecedented fiscal stimulus will continue for some years to come, Colesmith believes, but the economies of most developed countries will experience some fiscal tightening in the year ahead. Here, the lessons from history are stark. As economic cycles mature and central banks begin to withdraw monetary stimulus, market volatility tends to pick up—with the “taper tantrum” of 2013 representing an extreme example.
Says Colesmith: “We expect the transition in the current cycle to be more nuanced, given the unusual nature of both the downturn and the methods used to counteract it. Yields are likely to drift higher, but the ‘age of low yields’ seems far from over. Meaningful increases in central bank rates are likely to prove just as difficult in this cycle as they have over recent decades, with the debt overhang larger than ever.
In response to Colesmith’s thoughts, Peter Bentley, deputy head of fixed income and head of global credit at Insight, commented: “As we look for opportunities against this backdrop, we remain cognizant that fixed-income markets have evolved. Many holders of debt instruments are now primarily concerned with finding secure ways to match future cash outflows. A modest level of income is a welcome bonus in a strategy that is focused on high probability. However, there are still opportunities to add value.”
For investors, this means the picture is far from straightforward. Bentley notes that the differentiated nature of recoveries is an environment that is potentially highly beneficial to relative value strategies. In some markets, the rush to price in tightening cycles has resulted in markets anticipating scenarios that appear to have little connection to underlying fundamentals. A more moderate, but still solid, level of economic activity is also likely to result in highly differentiated pressures on corporate executives.
At the higher end of the credit spectrum, an easy environment to leverage is likely to increase the attractiveness of acquisitions, with credit downgrades potentially a risk worth paying. At the lower end of the credit spectrum, the difference in funding levels between investment grade and high yield remains sufficient incentive to deleverage.
Bentley concludes: “With this in mind, a bias toward selectively chosen lower-rated credits appears to be an attractive strategy. The extraction of structural yield premiums in markets such as secured finance and emerging markets also remains a viable strategy to potentially increase income.”
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Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others.
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