CIOs upbeat on bonds despite expected rate hike

Singapore

EVEN though the market expects the US Federal Reserve to hike rates after its Wednesday meeting, various chief investment officers (CIOs) and senior investment analysts are sanguine about the interest rate-sensitive bond market.

Ageing populations across the world still mean slow economic growth and a persistent demand for bonds, they said at a roundtable organised by the Investment Management Association of Singapore.

In fact, the interest rates and US dollar market is either fairly valued or a bit more bullish than it should be, they said.

Wang Qian, Asia-Pacific chief economist at Vanguard Investments Hong Kong, said that although she thinks short-term interest rates will hit 1.25 per cent by end-2017 after three more hikes next year, she does not think longer-term interest rates will rise significantly.

The current US 10-year Treasury rate of 2.5 per cent is "fair value". This is because global growth is expected to stay stagnant due to ageing populations. It also remains to be seen if fiscal policies will bring back "animal spirits" - a term used to describe a revival of investment and consumer confidence.

"From an economist's perspective, we see the world still in a structural deceleration characterised by unfavourable demographics and weaker productivity growth," she said.

The US economy can grow 2.5 per cent a year at best, she said. There are structural bottlenecks to higher growth given how its labour market is at full employment. Non-farm job growth will fall to around 130,000 jobs added every month compared to 230,000 previously, Ms Wang said.

"If people are so optimistic about growth or inflation, US Treasuries and the dollar strengthening will in turn hurt economic growth, tightening up financial conditions," she said, referring to how a stronger dollar causes exports to be less competitive, and how higher interest rates lead to higher borrowing costs. "Yes, we are cautiously optimistic about US growth but we think the upside is not going to be as great as some people are expecting."

Neeraj Seth, BlackRock head of Asian credit, is expecting two hikes in 2017 instead of Ms Wang's three. He thinks dollar strength is not a given.

Now, the momentum is in favour of the "reflation trade" of higher rates and a stronger dollar. He is wary of buying bonds with a longer period to maturity, which tend to be more interest rate-sensitive.

"Momentum overshoots, there's no point coming in the way of that right now. We are slightly short duration in our portfolios and will be looking at points to turn that position back," he said.

Desmond Soon, Asia ex-Japan head of investment management at bond manager Western Asset, said he actually saw more money inflows from investors recently.

"When yields go higher for these guys, they actually want to invest more, as it brings them higher payouts, higher coupons," he said. Bond prices and yields move in opposite directions.

Asian populations are ageing, he said. "What do potential retirees want? They want income that's more or less fixed . . . the demand for yield, fixed income is a secular trend."

CIOs said they were not too bearish on emerging markets, which are traditionally weaker in the face of a stronger dollar.

A strong dollar together with strong commodity prices can boost emerging markets, noted Anish Mathew, CEO and CIO of Sundaram Asset Management Singapore.

Mark Wang, CIO of NTUC Income Insurance Co-op, said Asian corporate bonds are still looking attractive, with a higher spread than their long-term averages compared to equivalent spreads in the United States. Spreads refer to the difference between bond yields and the relevant risk-free benchmark, and are a way to compare bond valuations.

Meanwhile, US stock valuations are hitting new records. But John Doyle, CIO of equities and multi-assets at UOB Asset Management, remains positive.

US companies continue to enjoy high returns on capital and free cash-flow yields, in a way that justifies their high valuations, he said. By contrast, South Korea has perennially traded at low valuations because it is a "horrible deployer of capital".

"We like emerging markets but are a bit more cautious," he said. In the space, he prefers Asia to Latin America or Europe, Middle East and Africa. "We will only get constructive when we get positive change happening to close the performance gap."