Rodriguez’s main message on the credit markets in relation to fixed income products is about risk. The fund house is much more cautious on credit risk across the globe than in the past, when it has been more constructive.
Aberdeen’s central case view is that the US Federal Reserve rate hikes will be slow while the Europe’s ECB and Japan’s BOJ are likely to continue their quantitative easing policies.
“[However], the risk of an adverse scenario in credit markets means it’s more prudent to take some of that risk off the table within the fixed income framework. Certainly the outcome will not be good if treasuries are selling off or they start to compromise the search for yield.
“Add in the overlay of valuations that are not as attractive as in the past and this blind chase for yield is something to be cognizant of.”
Moreover, in credit, liquidity going forward is likely to be worse than in the past, which can affect investors who intend to reduce exposure after any adverse market reaction.
“It’s important not to overstate the liquidity aspect of credit markets. “
It’s increasingly tougher to get the high yields of the past, he added. Distortions created by central bank interventions have created a trend of chasing the same yield target even as yields fall.
“Many investors sought to move down the credit spectrum to get a certain yield, for example from BBB rating to single B. We argue that’s taking on more risk as markets become more expensive. If the trend continues, the outcome won’t be a pleasant one.”
The year of the US dollar
Turning to currencies, Aberdeen is constructive on the strength of the US dollar versus the euro and the Japanese yen.
Rodriguez pointed out that US growth is starting to gain traction and indicators show that inflation is not a threat.
“That argues for a stronger dollar as Europe continues to underperform and aggressive actions in Japan are trying to depreciate the yen.”
Some Asian bonds denominated in local currencies may face downward pressure due to US dollar strength. While the US dollar can outperform a basket of Asian currencies, there are some notable exceptions such as the Indian rupee, he said.
“The risk premium with India’s new government and even the inflationary premium that comes with the credible central bank governor suggests both bonds and the currency can outperform.”
Dis-inflationary forces in certain markets could overwhelm the more positive US economic trajectory, but the likely result is that central banks in Europe and Japan will continue with their QE programs, which bodes well for the dollar, he added.
Treasury yields and inflation
US treasury bond yields should move higher as the fed is expected to start raising interest rates next year, he said.
“The questions are whether treasuries will suffer from here and if yields can be materially higher than current levels. That probably hinges on whether there are any inflationary threats.”
He sees 10-year US treasury bond yields around 2.6 – 2.7% by the middle of next year.
The worry is that Asian markets are correlated with any treasury selloff. One risk scenario is that the US labour market may be tighter than people think, Rodriguez said.
“The labour participation rate has been falling, which makes it more structural than cyclical and suggests a tighter labour market.
“We are keeping an eye on wage pressures, which haven’t been prevalent, and on the employment cost index, which is starting to show early signs of turning up. If inflation is a threat, then the fed is likely to take action.
“But inflationary pressures are not there and any kind of treasury selloff will be muted.”
The problem with treasuries is dis-inflationary pressure in other parts of globe, which puts opposite pressures on treasuries and how much they can potentially sell off, he said.
“That makes a treasury call an interest rate call, which is much more difficult than the currency call.”
Oil drop equals Asia boost
Another key issue in 2015 is the freefall in the price of oil. Rodriguez noted that the drop is supply driven, and the impact on the US economy is positive, as it helps boost consumption.
“Globally, falling oil prices make a major contribution to economic growth.”
At some point, lower oil prices potentially start to impinge on shale oil production, he added.
“But it’s important to note that even when people talk about the breakeven cost of shale oil production, fracking is only in the early stage of development so there is no line in the sand, no particular price point at which oil will have significant negative impact.”
Certain economies, such as Russia, Venezuela and Iran are hurt by falling oil prices. But in Asia, with the exception of Malaysia, most countries are big beneficiaries, he said.
“Low oil prices are a clear and distinct benefit for Asia.”
