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ROUNDTABLE

Retaining the shine

Rising uncertainty over trade, geopolitics, inflation, and business cycle will likely lead central banks to ease monetary policy

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The strong appetite for yield coupled with risk aversion have pushed segments of the global fixed income asset class into negative yield territory. Yet fixed income remains one of the best performing asset classes year-to-date. Our panellists share with us their outlook for bonds and the segments they find most attractive

John Woods
Credit Suisse
Chief Investment Officer
Asia Pacific
Develops discretionary and advisory investment strategies

With both the Fed and ECB tilted towards policy easing, the services sector holding up well and political risks receding, government bond yields are likely to rise moderately. Yields are still low and valuations remain expensive and suggest limited potential return. We keep a short duration bias in EUR government bonds.

In US dollar investment grade, the spread has remained broadly unchanged and we prefer to take shortduration positions. We expect the spread to widen further across tenors due to supply pressures. Asia IG offers relatively more stable returns, but valuations and carry are less attractive. We expect Asia IG to deliver a total return of 3 per cent in the next 12 months.

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We turned neutral on global high yield and expect limited positive returns before the yearend. HY fundamentals are deteriorating: Moody's has revised upward default rate expectations for 2020. USD CCC-rated bond spreads have risen and are indicating stress in the very low-rated segments.

We continue to be positive on Asia HY and expect 6 per cent total return in next 12 months. Authorities have taken action to prevent real estate from overheating, but they seem unlikely to act to constrain the sector given the weakness in manufacturing. Monetary policy will remain accommodative and regulatory constraints imply that new offshore issuance is likely to be mainly for refinancing purposes. This should work to ease default risk by forcing some deleveraging and also implies a creeping supply shortage. Yield of 7.3 per cent remains attractive relative to developed market and is not expensive versus its 10-year average.

In Asia, we prefer short duration credits given the flatness of the curve. A portfolio of short duration Asian credit with a blend of IG and HY should return around 4 per cent in the next 12 months.


Rajeev De Mello
Bank of Singapore
Chief Investment Officer
Investing in Asia since 2005

Bond markets have rallied sharply this year as the US Federal Reserve moved from tightening monetary policy to cutting interest rates. The European Central Bank and China's People's Bank followed suit and the Bank of Japan is also likely to move towards further monetary easing. The world's largest central banks are trying to reduce the risk to the economy of an economic slowdown. During the first half of the year, corporate bonds outperformed government bonds but then struggled during the strong rally in government bonds globally in August.

Over the next six to 12 months, we expect monetary policy to remain accommodative. Central banks around the world will keep easing policy as they see growth moderating and inflation staying low. Most central bankers are quite explicitly telling investors that they would like to see prices rise and will stand by even if inflation moves up. The headwinds to growth are unlikely to reverse suddenly. e trade tensions have damaged confidence and bond investors fear that central banks have limited room to ease policy when the next recession hits. Unlike during past easing cycles, quantitative easing, or bond purchases by central banks, are expected to be an integral part of the policy response.

Investors are eager for investments with high dividend or coupon yields, especially savers in countries with very low or negative interest rates.

Investors often view bonds as substitutes for cash deposits. By buying and holding an investment grade corporate bond until maturity, the holder can usually earn a higher yield than cash. However, high-grade bonds also have a diversifying effect on portfolios. During times of equity market stress, bond prices rise and provide a direct offset for declining equities. While bonds will decline in price during periods of rising equities, they still generate yield. For investors to fully benefit from the negative relationship between bonds and equities, they need to be prepared to buy bonds with maturities of longer than five years.

Inflation-linked bonds (also called Treasury Inflation Protected Securities or Tips in the US) are also attractive when inflation is expected to rise. ese bonds are currently pricing in very low inflation expectations, so replacing some regular bonds with Tips can be a way to benefit from higher inflation.

We also expect bonds to be well supported over the next six to 12 months. High quality investment grade bonds are a good diversifier for the equity side of a portfolio and some allocation to inflation-linked bonds could protect a portfolio from an unexpected rise in inflation.


Kelvin Tay
UBS Global Wealth Management
Regional Chief Investment Officer
Provides strategic research and inputs for investments and asset allocation

The global hunt for yield has not dissipated despite an estimated US$16 trillion worth of global bonds now with negative yields. Rather, the appetite for yield is unlikely to weaken anytime soon as rising uncertainty over trade, geopolitics, inflation (or lack thereof) and the business cycle will likely lead global central banks to ease monetary policy.

In August, the yield on US 10-year government debt fell below the yield on two-year government debt for the first time since the financial crisis. The fact that an inversion of the yield curve has preceded every US post-war recession has led Google searches for the term ''recession'' to spike. An inverted yield curve has not been historically proven to be a reliable sell signal for stocks. Returns for US large-cap stocks averaged 8 per cent in the year following an inversion, and 15 per cent after two years. And of the eight instances of inversion since 1965, returns in the following three years have been negative only once.

But sell signal or not, the inverted US curve does reflect some valid fears we see currently pervading sentiment. First, fear that the recent slowdown in economic data, mostly notable in the global manufacturing sector, will broaden and deepen. Second, fear that President Trump is willing to push the US economy into a recession to fulfil his trade objectives.

An environment of subdued global growth and central bank easing should see investors continue to search for carry in global credit, particularly as the stock of negative-yielding debt has climbed to a record high. However, credit spreads are unlikely to tighten much, given the weaker growth backdrop, and downside risks related to trade policy developments. In our base case, we see the US avoiding a recession next year, supported by a healthy US consumer. High yield defaults are likely to increase toward 2 per cent in Europe and 3 per cent in the US, levels still below their longterm averages. We would expect a global diversified credit portfolio to continue to be resilient, with carry to provide the bulk of returns going forward.

In Asia, we expect credit spreads for Asia HY (high yield) to widen by another 30-50bps to 630-650bps from the current 600bps. IG (investment grade) bonds in Asia, on the other hand, are expected to be more resilient given their high average Baa1/BBB+ credit ratings; spreads may widen by another 10-20bps. We position defensively over the near term, so we continue to prefer BBB bonds for IG and BB bonds for HY.


Yves Bonzon
Head of Investment Management and Chief Investment Officer
Julius Baer Group

The rally in government bond markets this summer has been nothing short of remarkable. While back in June we expected 10-year Treasuries to slowly recover to 2.5 per cent towards yearend, they plunged to 1.5 per cent, almost halving from their August 2018 highs. The sharp move was triggered by escalating trade tensions and heightened economic recession fears. It is crucial to note, however, that the 10-year Treasury yield is in fact a global yield, not necessarily reflecting US domestic fundamentals. We are concerned that the Fed underestimates this critical aspect.

Indeed, while tariffs and mounting uncertainty have made their mark in the global manufacturing sector (US PMI has crossed into contraction territory in August), US domestic demand and particularly consumption, remain supported by a healthy labour market and steady wage growth.

Systemic risk remains dormant; liquidity does not give a negative signal for risky assets; and investors' positioning still supports the rise of equity markets. As long equity markets remain resilient and asset price volatility stays low, as they have proved to be despite the record investor bearishness this quarter, the US economy has no reason to plunge into recession.

The level of unease regarding the consequences of political tensions has nonetheless clearly increased this summer. Up to a certain unknown breaking point, the trade war should actually extend the cycle, as central banks take a dovish stance.

In the absence of recession, it is more likely that government bond yields would increase rather than decrease in the coming months. As these lines are being written, they have already regained some ground, the US 10-year yield rising to 1.8 per cent and the German 30-year bund emerging out of negative territory. The mountain of global negative yielding debt has come down from its 17 trillion USD record high. At current yield levels, these longer-dated bonds could add little to a portfolio.

Strategically, creditors face three distinct risks: business, monetary debasement and confiscation risks. The first of these risks is available through credit and is still properly remunerated as long as the economy enjoys modest but positive growth. The price to pay is to accept reasonable short-term fluctuations in the assets' valuation. Excessive aversion to short-term volatility leads to excessive exposure to the other two strategic risks, increasing the risk of erosion of the real value of assets in the medium and long-term, and fully exposing investors to capital confiscation through the transfer of wealth from creditors to debtors, or in other words, through financial repression.