The recent performance developments for fixed income assets (all segments) have been disappointing. There are multiple reasons: a) adverse geopolitical developments, b) surging inflation (well beyond the expected), and c) a late start of the monetary policy tightening cycle. Actually, the market believes that CBs are behind the curve and hence the great performance stress.
The market expects now that the FED will raise interest rates up to eight times by the end of 2023. This implies an interest rate increase in each of the remaining six Fed meetings. In recent weeks, it was argued that the FED may do a number of 50bps increases and eventually be skipping the interval once. Therefore, the projections translate into a terminal value of around 3%.
With this in mind, where are the new sweet spots?
First of all, we believe that global growth is still valid but with some pockets of weakness, such as Europe, due to conflict at its eastern side. Therefore, and given that the FED communicates clearly and in an unambiguous manner, it can be expected, based on past scenarios, that conditions are good for a market recovery. Undoubtedly, ongoing global growth and tighter credit spreads are prerequisites for this to happen.
The main beneficiaries of this constellation are high-quality EM bonds, mainly from the Middle East and LATAM. While geopolitical risks have not peaked, we expect these two regions to be least impacted by any future events to come and that present prices have accounted for a bad outcome. Our focus goes to short-duration opportunities, ideally between three years to a maximum of five years. The enclosed list contains a number of USD and denominated bonds.
What about risks?
Oddly, the rate of inflation has gone somehow out of Central Bank control. Counter measures could include a faster than expected tightening process, which in turn could negatively impact consumer confidence, which in turn could impact the offer and demand equation for commodities, which in turn could translate into slower economic growth. All these would impact the short-term performance of bonds, but ultimately we would expect full repayment by the issuer. Other lingering risks are new spikes of COVID-19, an escalation of the Ukrainian conflict to Europe, and adverse idiosyncratic issuer events.