Although BNY Investment Management expects short-term US interest rates to be “higher for longer”, it sees value withing government bond markets.
“We prefer long duration in the US,” Adam Whiteley, head of global credit, Insight Investment, BNY Mellon IM, told FSA. Duration is more appealing now that US treasury yields are closer to the base rate level across the curve, compared with the significant inversion seen during this cycle to date, he explained.
“Given the extent of the move higher in yields, looking forward, we expect fixed income to once again offer defensive diversification in an asset allocation context,” said Whitely.
Credit valuations are broadly in line with their long run average, although Whitely (main picture) doubts that the credit spread component alone offers much strategic value. However, combined with the government bond yield, the absolute yields available today are at levels that have not been seen in 15 years.
“This, from an asset allocation perspective, is attracting a lot of interest from investors,” he said.
Sector preferences
Among sectors, Whitley sees “pockets of value in the property sector”, as it is further along than others in its cycle, and in particular likes logistics and residential property where there are more favourable demand/supply dynamics.
Given that the next phase of the broader economic cycle is likely to involve less growth and lower margins, he generally prefers defensive, non-cyclical sectors such as utilities, and remains underweight more cyclical sectors such as basics and energy. BNY Mellon Global Credit Strategy is also overweight senior bank bonds because of “attractive valuations and solid fundamentals”.
BNY Mellon Global Credit Strategy’s recommendations are predicated on its view that inflation is declining but is unlikely to get back to target over the next 12 months. It believes that interest rates will stay elevated through the middle of next year, and that the Fed will not start cutting rates until it is confident inflation is moving back towards its target over the medium term.
In emerging markets, BNY Mellon Global Strategy has long positions in local rates including Brazil, Mexico and South Africa. “While the value in local rates markets looks less attractive at current levels when compared with US Treasuries, the macro perspective still offers some offsetting support,” said Whitely.
Meanwhile, technical factors continue to be supportive for emerging market corporate bonds, given lower than expected issuance and defensive investor positioning, even though valuations are less compelling, he added.
Risks to strategy
Although the balance of economic growth and inflation, and the US Federal Reserve’s response are key factors that will affect any fixed income strategy, Whitely also identified geopolitical and domestic politics as major risks.
If the Middle East crisis spills over elsewhere, that might quickly lead to higher oil prices, which would fuel higher inflation and possibly tighter monetary policy. Meanwhile, domestic politics, notably the US presidential election next year, could also be a risk factor, he warned.
