Fixed Income 2Q’15: Searching for Yield in a Low Rate Environment
TOM BUTCHER: Hello and welcome. I'm Tom Butcher and I'm here with Fran Rodilosso, Senior Investment Officer at Van Eck Global. Our focus today is fixed income as we enter the second quarter of 2015. Fran, thanks for joining me today.
FRAN RODILOSSO: Thank you, Tom.
BUTCHER: What do you consider the main themes as we enter into the second quarter of this year?
RODILOSSO: There are several. Not to rehash the first quarter, but certainly some of the themes that dominated price action and returns in the first quarter are going to continue to be major themes for the rest of 2015 and definitely in the second quarter. The Fed and the direction of policy will matter, i.e., the Fed’s direction and timing. The ECB and the effects of their quantitative easing program are also factors. The dollar begs the question of whether its strength will resume and continue to impact returns on international investments particularly. With respect to commodity prices, oil is most significant terms of grabbing the headlines. Oil’s impact on headline inflation and its impact on some emerging market countries will matter. All of these themes are obviously tied into one another. In terms of my thoughts about the second quarter, I’ll start with the Fed. They have made it fairly clear that their intention as it stands now is to raise target rates at some point later this year. They've also continued to make it clear that they are data-dependent. In that one area, I think the Fed is believable in that they are data-dependent, and I think it does leave the question open of how quickly, and exactly when they'll start. On the other hand, I do think there's a proof of concept issue; the Fed is determined to raise rates to show they can. I believe there are very low odds we'll be seeing that in the second quarter. But how does it affect the rest of the curve? That’s a big question for the second quarter. Actually, there was a great deal of interest rate volatility in the U.S. during Q1, and as the market reacts to data and tries to read the Fed's tea leaves, you probably can expect more volatility in rates in the second quarter. Ten-year yields had a range of about 50 basis points during the first quarter of 2015. That's fairly wide when you think absolute rates are just under 2% on the ten-year as of the end of the first quarter. In a nutshell, I think the market is preparing itself for higher rates but is actually fairly comfortable with the idea that the curve can stay relatively flat: the U.S. treasury rate curve, that is. In the context of the base rate, the risk-free rate, above –which most of the rest of the fixed income world is priced, the market remains comfortable with duration, and I think that's a fair place to be right now: comfortable with duration and comfortable with the idea that beyond five years there is a lot of downward pressure on rates. Why is that? One: the strong dollar has had a tightening effect in a way, and that will keep downward pressure on rates. Two: the ECB's buying program is spreading way beyond Europe. They are basically exporting QE. They need to export more of their own real goods, but they are exporting their QE, and it is forcing buying of long-dated bonds in the U.S. as well. Three: growth is still not there globally. Commodity prices are weak. Growth generally has still remained disappointing. Actually, it is less so in Europe, but you're talking off a very, very low base. Within most of the emerging world, growth has been somewhat disappointing. Inflationary pressures still seem moderate. The Fed has said we might not need to see headline inflation at 2% before we move. What does that mean? Where do investors go for returns in the second quarter? We never know for sure, of course, but I will mention that investment-grade corporate debt continued in 2014 through the first quarter of 2015 to see fairly strong interest from investors. You're getting 3% yield instead of 1-2% yield. Investors seem comfortable with credit risk at that level. During the second half of 2014, investors shied away very much from high yield and from emerging markets, and we saw some of those markets suffering. There was some bad news in emerging markets. There was bad news in the energy sector and high yield. What you can say for those markets is they adjust. Spreads did widen fairly significantly. The U.S. high yield market has had a spread range of nearly 200 basis points since the middle of 2014. While you might not argue that any part of the fixed income world is particularly cheap, on a relative value basis you can say those price adjustments and that spread widening has brought some value back into the high yield market. I would say the same for emerging markets.
BUTCHER: Fran, thank you very much.
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