After a surge in post pandemic global inflation and a series of central bank interest rate hikes designed to contain it, markets now find themselves pondering when and which way banks such as the US Federal Reserve (Fed) will move next.
For now, central banks appear to have reached a plateau on hiking rates, says Insight’s Shaun Casey, with some making modest rate cuts.
In June the European Central Bank cut interest rates for the first time in five years2, with the Bank of Canada also cutting rates by 25 basis points3. This new less aggressive stance on rates could, adds Casey, be good news for fixed income investors.
“Looking ahead, we believe central banks are likely to be more proactive than reactive in terms of reducing interest rates from where we are now and this could be helpful for fixed income investors. Historically, long interest rate pauses in raising rates, particularly the US Fed rate, usually present a positive backdrop for both equity and bond returns,” he adds.
Market divergence
In this economic environment, Casey says he believes global credit is looking increasingly attractive. Rising yields which can help fuel income generation, geographic market divergence and comparatively low default rates all augur well for the sector, he adds.
“We believe opportunities in the global credit market are as good as they have been for the last decade and we are seeing strong demand for credit as an asset class from a range of investors, including multi-asset managers. One of the key drivers of this demand has been a rise in yields, which has seen many investors start to achieve equity style returns on their fixed income investments in what has become an increasingly supportive environment for credit spreads.
“In terms of divergence - and from a global standpoint - not all global economies are built equally. And with monetary policy regime at a potential pivot, we see relative value opportunities opening up across a range of markets as their economic performance and interest rate policies diverge.”
According to Casey, heightened volatility is also creating pockets of opportunity active managers are well placed to exploit, with a major global election year bringing heightened uncertainty levels to markets.
“This is a huge year in politics with a remarkably high number of elections taking place across the globe. With a US election in particular coming up in November markets face some unpredictable outcomes. All of this holds the potential to fuel uncertainty and wider market volatility,” he says.
Global approach
Against this volatile backdrop, taking a global approach can bring real benefits, adds Casey, helping investors to navigate more regional and country specific problems or crises.
“Going global can offer a wider, more varied opportunity set than focusing more tightly on specific markets. Regional economic flare ups such as the 2022 UK gilt crisis, the European sovereign debt crisis or the slump we have seen in the Chinese property market are typical of the types of scenarios most investors would want to avoid. Taking a global approach can give them the flexibility to do so.”
From a default standpoint, Casey sees a broadly benign outlook for investment grade credit, but still counsels against market complacency.
“With the upward trend in interest rates and inflation we have seen since the central banks’ response to the global financial crisis (GFC) ushered in ultra-low rates there is a sense of normalisation and a return to a supportive environment for fixed income. Yet defaults are still real.
“As much as the economic backdrop might be decent and risk asset returns over the last quarter have been very positive, it doesn’t take much for markets to become spooked. There may be some who genuinely believe “this time it is different” but, in my view, those are potentially four of the most dangerous words in investing!”
Market resilience
According to Casey there are, however, some genuine reasons to take a more relaxed view on potential defaults. Strong corporate balance sheets, improved lending standards and lessons learned from the GFC all provide a degree of comfort across credit markets, he adds.
From a sectoral perspective, Casey believes the banking sector offers some particularly strong potential credit opportunities. Despite some high-profile problems in banking last year, notably among some smaller US regional banks, Casey believes the sector has become increasingly well-regulated and could offer significant value to select investors.
“We don’t feel last year’s banking sector problems were systemic so much as down to more specific factors such as short-term management problems. Since the GFC our view is that regulators and the industry itself have generally succeeded in making banking much safer and less risk prone than it was. We believe banks are in decent shape, the sector offers some genuinely strong opportunities and that valuations within the sector remain relatively cheap,” he concludes.
