Today’s global fixed income markets are highly volatile, and using a six-month outlook is one way that the Plus Fixed Income team at Allspring Global Investments navigates these changing environments. Janet Rilling, senior portfolio manager and head of the Plus Fixed Income team, shares her thoughts with Danny Sarnowski, portfolio specialist for the Plus Fixed Income team, on how the team uses this outlook and where they see things moving going forward.
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Danny Sarnowski: Hello, I’m Danny Sarnowski, portfolio specialist for the Plus Fixed Income team, and you’re listening to On the Trading Desk®. Today’s global fixed income markets are highly volatile. There’s a lot going on. And using a six-month outlook is one way that the Plus Fixed Income team at Allspring Global Investments navigates these changing environments. Today I’m joined by Janet Rilling, senior portfolio manager and head of the Plus Fixed Income team. And she’ll share her thoughts on how the team uses this six-month outlook and where they see things moving going forward. Janet, thanks for being here.
Janet Rilling: Hi, Danny. And thanks for inviting me to the discussion.
Danny: Janet, fixed income markets in 2022 have been exceptionally volatile. Interest rate volatility has led to the worst fixed income returns in 40 years. And inflation in the U.S. is the highest it has been in a generation. Now recently, the U.S. Federal Reserve tightened monetary policy yet again as they work to subdue inflation. Could you provide your perspective on where things stand with the Fed (Federal Reserve) and how investors could consider interest rate exposure at this point in the cycle?
Janet: Looking at the big picture, the Fed has tightened 375 basis points (100 bps equal 1.00%) since March. That’s almost 4%. This is the most they’ve ever raised in such a short period of time. Also, it was the fourth consecutive 75-basis-point increase. Both of those data points are not normal. We haven’t seen them before in the past. Fed Chair Powell has made it very clear that it’s too early to talk or think about pausing rate hikes at this point. And his statement reinforced our view that there’ll be additional hikes at their December meeting and into early 2023. Powell also stressed that investors should focus on the terminal rate—the point where they’ll stop hiking—rather than the path that gets us there. And he reiterated that the terminal rate is higher than previously expected. So, while those statements were hawkish and the risk continues to tilt toward higher yields, we believe that the Fed and the market has already done a lot of the work to move rates in that direction. We should also be reminded that monetary policy works with a lag. And the cumulative impact of all of that tightening has not yet made its way through the economy. So, as a result, over time, we do expect to see an impact on the economic fundamentals. And at that point, the Fed is likely to pause and the terminal rate will be reached. So, with all that in mind, we think the time to be most short duration or, in other words, worried about rising rates has likely passed. Instead, we think cautiously adding some duration could be beneficial at this point.
Danny: Great. Can you spend a little time telling us about how this volatile year for fixed income markets has affected credit?
Janet: Well, credit markets have underperformed in 2022 and spreads, which are the additional compensation an investor earns for bearing credit risk, have widened. But context is important here. Spreads have widened off a very tight level set last year. And, in our opinion, they still may not be compensating investors for the risks down the road. When we look at corporate fundamentals, they’ve definitely recovered from the pandemic and are back to 2019 levels, which is good news. But the bad news is that those fundamentals by and large were the weakest levels of a 10-year bull market. We take a view of markets through a six-month time frame. And we’re not expecting an imminent drastic recession in the U.S. But we are expecting that the weight of monetary policy will impact economic growth. And as it does, we expect spreads to widen further. And that’s because when we look in a historical context, current spread levels don’t seem to be compensating the investor for the very real recession risk. That also means now is a good time for an investor to consider how much credit exposure they have in their portfolio and then give themselves room to take advantage of better prices for credit in the future. This approach may also be easier to do now than it has been in the last several quarters. And that’s because as one moves up in quality, in many cases that results in the same yield or even higher than would have been earned in the past with a riskier bond.
Danny: What are your views on the global landscape? Are the same market dynamics that we find here in the U.S. playing out abroad?
Janet: We are seeing similar dynamics play out. We are not the only country going through a range of issues. Things like high inflation, extremely aggressive central bank policy, weakening economic fundamentals—these are all global issues. In Europe, things are even more complicated by the energy crisis and the looming winter. Things are likely to get more difficult for many countries before they get better. And since markets are connected, this global picture also increases the risk to the U.S. A problem in one market can spill over to another. We recently saw this play out in the U.K. The policy confusion between their central bank and their government first hit the gilt market but then had serious knock-on impacts for U.S. Treasury yields. But these issues also present opportunities. The German bund, for example, has seen its yield turn positive after trading at a negative yield for years. Foreign exchange-hedged bonds actually right now yield more than 100 basis points than the U.S. Treasury. This is just one example of how global dynamics can present interesting opportunities for investors.
Danny: Well, Janet, it sounds as though you and the team expect that the Fed will move up to the terminal rate and that rates could continue to see some volatility and that you expect credit markets to see some weakness or some volatility over the next six months. How do you and the team, using your six-month outlook, think investors should be positioned, or where are they going to find opportunities in this sort of environment?
Janet: Well, as always, it will depend on an investor’s own risk tolerance and time frame.
Danny: Sure.
Janet: But for investors that are focused beyond immediate cash needs, we think adding incremental duration here offers the chance to take advantage of higher yields. And it also prepares a portfolio for when the Fed opts to pause rather than hike again. We would also be mindful of credit exposure, as we touched on before, and look for ways to build optionality into portfolios. As conditions change and prices shift, the opportunity to source liquidity to exploit those cheaper valuations will be important. And we think keeping a global perspective matters, given that opportunities and risks are likely to pop up around the world. All-in yields are at the highest level they’ve been for bond investors in nearly 15 years. Market conditions are challenging but present good opportunities to source income for investors, which in the end is the key driver of total returns in fixed income.
Danny: Well, Janet, that sounds like fixed income markets offer a lot of opportunity, but maybe not a lot of easy answers, which is, again, why you and the team using that six-month outlook and staying nimble and using those multiple levers at your disposal are very important for fixed income investors at this point. I truly thank you for joining me. I appreciated the conversation and I look forward to talking to you again On the Trading Desk®.
Janet: Thanks, Danny. It’s been great talking with you.
Danny: Well, that wraps up this episode of On the Trading Desk®. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com. To stay connected to On the Trading Desk® and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you get your podcasts. Until next time, I’m Danny Sarnowski and thanks for listening.
Disclosure: 100 basis points equals 1.00%.
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