Fixed Income Focus: Economy, Elections, and Eggs in One Basket?

George Bory: I'm George Bory, chief investment strategist for Fixed Income at Allspring, and welcome to SpringTalk. Today, I'm here with Noah Wise, senior portfolio manager for the Plus Fixed Income team at Allspring. Thanks for joining us, Noah.

Noah Wise: Thanks for having me.

George: Noah, let's jump right into it. I think you'll agree it's been a pretty good year so far in 2024, at least economically. The economy is expanding at roughly 3%. The labor market looks good. Corporate earnings are likely to be up solidly in the first quarter. And with all that good news comes basically sticky inflation. Inflation remains a little bit hotter than perhaps policymakers would like. So, I guess really the main question for you and the team: Is this scenario consistent with your team's expectations coming into the year?

Noah: Yeah, we came into this year, actually, having shifted into a more positive view on 2024. Kind of rewind a little bit into October, November of last year and we thought recession risks were receding quite a bit. So, a lot of the growth data and even earnings data that we're starting to see here has not been too surprising to us. But you put your finger right on it. It's more on the inflation front. And interestingly, not even the headline inflation numbers because those have continued to move down here more recently. It's actually when you kind of look under the hood and then see some of the underlying trends and some of the stickier measures of inflation. And particularly on the service side of the economy, we've seen that start to reaccelerate. That's the area that we're really, really focused on. And we're going to get a really important data print on March 12. We're going to get the February CPI (Consumer Price Index) figures. And the focus there for us in particular is going to be some of those core service measures of inflation to get an indication of is this a change in the trend?

George: So, what do you think that means for the Fed (Federal Reserve), most importantly, and then, for the rest of the year. We'll talk about markets. We'll talk about positioning later, but just about economics. What does it mean for the Fed and what does it mean for the remainder of 2024?

Noah: Yeah, the Fed has really gone out of its way to signal that the hiking cycle is done. But they've also been trying to indicate that they want some flexibility in terms of when they're actually going to start cutting rates. And the reason for that, I think, is on this inflation side. The growth data gives them cover to wait on cutting the inflation data if there are concerns around the trend in inflation. Then, that potentially could push rate hikes back. And the other part that is a little bit surprising here and I think has kept rates a little bit higher for longer than most were expecting is just the amount of financial easing that we've seen. The markets have really been, I think, doing some of the Fed's work for them, kind of in the almost opposite fashion of what happened in October of last year when markets were actually doing some of the tightening for the Fed. Over the last couple of months, we've seen that financial tightening from the end of last year actually be completely unwound. And now, we're seeing financial conditions ease to the extent that they're the easiest that we've seen really since 2022.

George: That's a good lead into just markets in general because the bond market had a huge rally at the end of last year. We've given some of that back, but it's not very evenly distributed. High-quality Treasuries are higher in terms of yield prices down. Bunds over in Europe, similar type of scenario. And as you go down in quality, basically your price performance gets better. Yields have gone up less and in some instances are actually even lower. So, as we look at these markets, is this fully justified from a fundamental perspective or is there a broader technical consideration that is also driving this divergence, if you will, of both yields and prices in bonds?

Noah: Yeah, there's certainly some of both, but maybe starting on the rates market. The better growth and some more of the ambiguous inflation data definitely support yields being a little bit higher and that's what we've seen so far. So, we think that makes a lot of sense. But on the technical side, we've actually seen an incredible amount of corporate supply. This is especially true in the U.S. Despite that, spreads remain really well behaved. And we think that a lot of that reflects just the positive technicals in the amount of yield buyers that are out in the market. I think investors are not the only ones that are looking forward to higher yields. And I think there's a lot of investors that were under-allocated to fixed income for a really long period of time. Now we're starting to see some of those investors come back into the market. And I think that's really supporting the valuations in some of these credit sectors.

George: I want to pick up on something you mentioned before. You used the word "flexibility." You were talking about the Fed. But flexibility in this market is critical. And one of the things that the Plus Fixed Income team does is be flexible. And that's one of the characteristics of the team and being very nimble and being able to move risk around as both opportunities present themselves and as the facts ultimately change. So, as you think about 2024, you mentioned it's been unfolding largely as expected. One big factor hanging out there is the U.S. presidential election. It's not economic at all. It's in fact somewhat binary. How do you think about that in terms of risk in the portfolio, especially given the need for flexibility? And what could be the potential outcomes from an uncertain election?

Noah: Elections, if we've learned anything over the last number of cycles, it's that elections are incredibly hard to predict. What may be even more of a challenge is the market's reaction to those elections. And so, even if we knew how things were going to shake out, it wouldn't necessarily tell us how the markets would react to that. So, I think that really gets back to the benefit of that flexibility and really just proper risk management. Flexibility and risk management are two sides of the same coin. What that allows you to do, as you mentioned, is react to different types of market environments, not only to be opportunistic and take advantage of opportunities, but also to avoid some of the downside. And that's an important part of what we do as bond managers. We are always thinking about the downside. And I think always maintaining flexibility is an important component to proper risk management.

George: So, then when we look at the Plus products, how are you guys positioned, if we think about the major risk categories: duration, curve, broad sectors, the different mega sectors that are available as well as U.S. versus the rest of the world? You've touched on a few of those, but if you could summarize your risk positioning across the portfolios, how would you do that right now?

Noah: Absolutely. So, from a high level, I'll just start with our rates exposure. We're roughly neutral positioned in duration, but we actually do have a number of exposures underlying that. So, we're not just neutral rates across the board, even though we're neutral at a high level. We like the front end of the curve in the 2- to 5-year part of the maturity spectrum. Not only does it have higher yields than further out the curve, but we also think that's an area that is less likely to see rates move higher. We were talking about the Fed earlier. The Fed may end up pushing rate cuts back a little bit further than what the market is expecting. But we don't think the Fed's going to resume hiking rates. And so, we think the front end has a little bit more cap on the upside, which is a good thing. Further out the curve, there's actually potentially more risk. If we see longer run rates move higher due to inflationary surprises, then you could actually see 10- to 30-year maturities underperform. And so we're underweight that part of the curve. If you look at the U.S. versus global, this is an area again where we want flexibility. What does flexibility mean? A lot of times it means diversification, having exposure to more things. If you have all your eggs in one basket, that concentration risk can really impede your flexibility. And so we do have some exposure outside of the U.S. We think that there's pretty attractive rates exposure in Europe. The U.S. is growing and doing incredibly well, as you talked about earlier. That's not really the case everywhere in Europe and that can actually be a positive for bond markets. It can mean yields that can move lower, so we do like some rates exposure in Western Europe. Australia is another market that we have a favorable view on. So, really from duration and rates, we think diversifying across the curve but also globally makes a lot of sense.

George: How about in credit markets, whether it's structured credit, corporate credit, investment-grade high yield? Just quickly some key themes there?

Noah: Yeah, I think credit is tricky at this point. We talked about the positive technicals. Well, what does that mean? That means pretty unfavorable valuations, right? We have a pretty positive view, but it's already priced into the markets. And so, we're in a situation where we don't want to run for the hills. We do have a pretty positive view on the economy here going forward. But that means that you have to be a little bit higher quality. You don't want to be reaching for yield at this point in the cycle because you're not getting compensated for it. So, you really have to be disciplined from that perspective. We also do find some attractive opportunities in a diversified array of structured credit. Spreads there are relatively wider. We think that there is a bit of value. It's an area where you can maintain some carry but, again, has less downside risk if the markets were to become surprised by any type of exogenous shock.

George: Well, Noah, as always, it's been a fantastic and fascinating discussion. There are many moving parts in the bond market. Being flexible and capturing those opportunities is exactly what you and the team do day in and day out and looking forward to that this year, as well. Thank you so much for being on the show.

Noah: Thank you for having me.

George: And for our audience, thank you for joining us on SpringTalk.

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