With the Federal Reserve signaling that they’re done raising rates for the time being, Noah Wise, senior portfolio manager for Allspring’s Plus Fixed Income team, and George Bory, chief investment strategist for Allspring Fixed Income, discuss their views on the current interest rates situation and how investors might want to consider positioning their fixed income portfolios in this type of environment.
Noah Wise: We think that, really, key for investors is to focus on consistently applying a disciplined and successful approach.
George Bory: That’s Noah Wise, senior portfolio manager for Allspring’s Plus Fixed Income team. And I’m George Bory, chief investment strategist for Allspring Fixed Income, and you’re listening to On The Trading Desk®. Noah, good to hear from you.
Noah: Glad to be here.
George: All right, Noah. Let’s kick it off. We’re going to talk a little bit about what’s going on in fixed income, and more importantly, what the future might hold. Over the last couple of weeks, the Fed (Federal Reserve) signaled that they’re done raising rates, but they also emphasized that they’re not prepared to cut. So, maybe, Noah, you could talk a little bit about your views and our team’s views on the current interest rates situation and then really how investors might want to consider positioning their fixed income portfolios in this type of environment.
Noah: Yeah, absolutely. And I think you really put your finger on it and starting the question out within the context of what the Fed has been doing and thinking because historically, that’s been a very, very good time to aggressively get long duration in portfolios. Now, we’ve been advocating a more gradual approach, gradually extending interest rate exposure in portfolios. And the reason that we’ve advocated for a more gradual approach rather than a really aggressive approach is, in part, the famous quote, prediction is difficult, especially about the future. And what we would say is prediction right now, particularly around rates, is especially difficult. And that’s because we have levels of inflation, deficits, and debt, and really the combination of those three all occurring at the same time, unlike we’ve seen in the past. And so, we think you need to have a little bit more humility around those types of predictions but still recognize that you want to be adding some interest rate exposure into this environment, just maybe not as much as historical precedent maybe would imply.
George: I think, as you suggested, bond yields have gone up considerably over the course of really the last almost two years now. And so, valuations have changed pretty dramatically. And what we emphasize as a bond investor, the yield and the income you generate in your portfolio is traditionally the biggest driver of performance. How are you and the team thinking about valuations? And where do you sort of see the most attractive opportunities, given this dramatic revaluation we’ve seen pretty much across the entire fixed income market?
Noah: Absolutely. There have been some seismic shifts and some of these changes in in relative valuations have really driven some pretty significant changes in our portfolios. The first one I’ll highlight is agency mortgages. Agency mortgages is an area where we had a pretty significant underweight for most of the last couple of years, had been adding to that sector, and now have an overweight exposure. And the reason for that is the change in relative value. It is both fundamentals, but as well as technical factors. We’ve seen spreads increase to some of the highest levels we’ve seen in the last couple of decades. I’ve also seen, obviously, an incredible increase in interest rate volatility and that’s part of the reason why agency mortgages have underperformed, particularly in 2022. But as we talked about earlier, the Fed coming towards the end of its fed hiking cycle is usually a good indication that interest rate volatility is going to start to normalize. And if that does occur, that’s going to become a tailwind for agency mortgages. And the last thing I’ll highlight is just less supply in this sector. We think there’ll be a positive technical that supports agency mortgages just because housing activity has slowed down so much as a result of these higher interest rates on mortgages. The other sector of the fixed income market that we find really, really attractive is developed market global government bonds. And in here, again, it’s a combination of certainly changing valuations but also some important technical and fundamental drivers, as well. On the fundamental side, recession risks in Europe are quite a bit higher than what we’re even seeing in the U.S. But in Europe, we also have lower levels of deficits and less overall debt outstanding. That, we think, is going to result in less of a supply headwind than what we’re seeing in the U.S. Treasury market. And another important factor is really the yield difference. For most of the last decade, we were seeing negative yields in quite a few countries in Europe. And that’s a difficult environment, obviously, for fixed income investors. Those interest rates have changed quite a bit in Europe. Now, we’ve seen significantly positive yields. But just as importantly, we’re actually seeing the yield difference between treasuries and global government bonds decline quite a bit. So, better valuations on that front. And then, the last thing I’ll highlight is as U.S. dollar-based investors, we’re actually getting an incremental yield and income as a result of hedging some of those Euro-denominated assets back into U.S. dollars and, overall, results in a really attractive relative value opportunity.
George: Seems like perhaps the two most important factors are diversity of ideas, different segments of the market to try and monetize the opportunities, but also quality. Kind of cuts to the heart of a bond portfolio and when bond yields are moving around like we’re seeing currently, that creates a lot of price volatility in the market. And one of the things that can be really important when you manage price volatility is your investment time horizon. And one of the distinctions of your team’s approach to the market is trying to take a disciplined view. And your team takes a six-month view, why is that important?
Noah: It allows us to look through a lot of the short-term noise, to be able to take advantage of opportunities, and, ultimately, to be more tactical and opportunistic and seizing those opportunities for clients. But the other thing is that it actually provides us a little bit more clarity. It’s not so long of a time horizon that it impedes being able to act with conviction. We talked about our interest rate exposure earlier. I think that’s a good example. We had been underweight in our interest rate exposure for most of the last couple of years and now, more recently into this year, have moved to an overweight exposure. From a sector standpoint, we talked about agency mortgages and going from an underweight into an overweight and global government developed market bonds from an underweight to an overweight. On the other side, we had been overweight credit and we have been reducing credit because the relative value there has been diminishing. So, there’s a lot of ways to be able to employ that. It is, I think, beneficial, even for the larger opportunities when there is more volatility in the market. But it also allows us to be tactical and opportunistic and taking advantage of some of those smaller opportunities. In March of this year, we saw a lot of volatility around the regional banking crisis. And we saw some pretty meaningful dispersion in how different sectors of the fixed income market were behaving. And we were able to take advantage of some of those smaller opportunities, as well, where we first added into U.S. high yield during that period because it had underperformed and relative value became more attractive. And over the last couple of quarters, it has started to outperform. We’ve actually been able to reverse that position and sell back into a stronger market. So, we think that that six-month outlook has a lot of value for our clients and how we implement that in their portfolios.
George: So, let’s dig into that just a little bit more because post-COVID, price volatility in bonds have been much higher than it has been for the last several years. And it’s not just yield. It’s credit spreads. Are there some specific things maybe in addition to the six-month outlook that you and the team do to try and help both quantify, compartmentalize, and then, ultimately, use volatility to drive those risk-adjusted returns?
Noah: Volatility that we’ve seen in the markets can be frightening, but it actually can be an opportunity to drive some consistency in our portfolios. And we think that key for investors is to focus on consistently applying a disciplined approach. And for us, the consistent approach that we employ is one that utilizes the six-month outlook but also uses multiple levers to be able to generate value for portfolios, as well as an unbiased approach. And so, in terms of the multiple levers that we do employ that helps with building a more diversified portfolio, again, that ultimately, we think results in more consistent outcomes for clients, which is very, very important even in volatile markets. But it also allows us to look more broadly for opportunities. And the last piece is really utilizing this unbiased approach. And when we talk about non-biased approach, it’s not us as investment professionals not having biases. We all do. But it’s really in how we construct the portfolios. It’s for those portfolios to be able to perform in more types of environments. And again, that gets to the heart of being able to generate consistent outcomes for clients. And what does that mean? Well, that means that we don’t always have a really aggressive overweight allocation to something like credit or we’re not always overly exposed or underexposed to things like movements and interest rates. Instead, we will adjust portfolios to take advantage when the risk premiums and the opportunities in those types of areas are more attractive for investors or reduce those allocations and exposures when they’re less attractive. And so, that’s how we look at an unbiased approach and ultimately, with the six-month outlook and the multiple levers, we think has really helped us to generate more consistent outcomes for our clients.
George: I think it also cuts to the heart of humility. Being unbiased means you’re willing to acknowledge your successes, as well as some of your shortcomings. But, Noah, thanks for joining me today.
Noah: Thank you.
George: Good. And for those listening, thanks for joining us on this edition of On the Trading Desk®.
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