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Absolute returns in all environments

Tim Haywood, investment director for absolute return fixed income strategies, shares his views on the current macroeconomic environment and opportunities in the bond markets.

What is your view on the European Central Bank policy?

The economic environment in Europe continues to improve and in areas such as unemployment, the ECB’s forecasts have significantly undershot realised gains. However, the impact of recent currency appreciation on inflation appears to be surprisingly limited, and Mario Draghi’s decision to push back any amendment to the ECB’s programme of quantitative easing provides the governing council with valuable time to analyse changes in the economic backdrop.

And the US Federal Reserve?

Janet Yellen’s presentation at Jackson Hole provided little insight to her plans for monetary policy. However, with non-farm payrolls disappointing in August and FOMC members questioning inflation models and public policy, there is certainly scope for any further rate hikes to be pushed deeper into 2018. The cost of hurri-canes Harvey and Irma may create dips in activity followed by re-building.

Federal elections were held in Germany on 24 September. Do you think that the close victory for Angela Merkel supports German government bonds?

Financial markets generally do not like change in politics where the incumbent is viewed as sensible. Angela Merkel is a known commodity, whose fiscally conser-vative stance has been supportive of the bund market. However, it is not the Ger-man Chancellor who drives that market, but the ECB president – Mario Draghi’s interest rate policy and bond-buying programmes are far more important in that regard.

Where do you see investment opportunities in the emerging markets and why?

We see value in local currency debt in the higher yielding emerging world, which appears attractive on a relative value basis compared with converged and develo-ped market equivalents. This should benefit from strong demand continuing in the year ahead, as many investors are still very under-invested on a historic basis. Furthermore, inflation in the emerging world is subsiding, enabling central banks to start easing (or at least stop tightening) monetary policy rates at surprisingly rapid pace, which of course benefits fixed income investors.

What are the most interesting areas in the developed markets? Do you pre-fer governments or corporates bonds?

It is hard to find value in the developed world government bonds or in most corpo-rate debt, with Austria and Apple Inc. being the latest examples of very low cou-pons offered. This does not mean these markets are devoid of opportunities. Long / short and relative value strategies between government bonds are an important aspect of our current investment strategy. Longer-dated Treasury bonds remain an important safe haven asset compared with exhausted short-dated European government bonds. Credit spreads on actively traded corporate debt have narrowed to skinny levels from which widening has hitherto ensued – buying credit protection with associated options as a package helps make money in any rebound but limit losses for little cost if the tightening trend continues. Value can be found in alternative forms of credit, such as trade finance bonds, either insured or guaran-teed, which is an exciting example of a new sector born out of bank disintermedia-tion, an opportunity that our funds have embraced.

What is your view on the US dollar? Do you think that the recent rise of the euro versus the dollar will continue?

The Greenback is one of the worst performing currencies in 2017 and it is fair to question whether it can weaken much further. However, the Federal Reserve is likely to keep interest rates on hold for the remainder of the year and the ECB is expected to announce a tapering of its bond buying in October. Consequently, further weakness versus the single currency is more likely than not, but the dollar appears oversold and there is potential for those shorts to be unwound.

Next Finance , October 2017

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