Podcast: Finding a New Equilibrium in Fixed Income
George Bory, Chief Investment Strategist for Allspring Fixed Income, hosts Jamie Newton, Head of Fixed Income Research and Deputy Head of Sustainability, to discuss the recent bout of volatility in markets, what could happen, and ways fixed income investors could find a new equilibrium.
Transcript
George Bory: I'm George Bory, chief investment strategist for Allspring Fixed Income, and welcome to SpringTalk. Today, I'm joined by Jamie Newton, Allspring’s head of Fixed Income Research and deputy head of Sustainability. We're going to discuss the recent bout of volatility in markets, what may happen in the coming months, what Allspring Fixed Income is doing in portfolios, and ways fixed income investors may want to position their allocations as fixed income markets find a new equilibrium. As I mentioned, an intense bout of volatility swept across most major markets in early August on the heels of a weaker-than-expected U.S. jobs report from July. This has left many, many investors really scratching their heads, trying to decide if the moves are simply a recalibration of overcrowded positions or something more sinister. Are we on the cusp of a possible recession? Is this the start of a deeper slowdown? There are many questions. So, with that as an intro, Jamie, welcome to SpringTalk.
Jamie Newton: Thank you, George. Happy to be here.
George: All right, Jamie, let's get started. So, what's your take on this big upsurge in volatility? It was fast. It was furious. How has it impacted the market and, really, what's your perspective from a research point of view?
Jamie: Well, let's go back and set what happened. A couple of weeks ago, so at the end of July, the BOJ (Bank of Japan) surprised the market by raising rates from 10 basis points to 25 basis points. Now, you might think a 15-basis-point move isn't much, but it's quite a number when you sit at 10 basis points. Additionally, the following day, the U.S. got some employment data, which was a bit more of a surprise, as well. The unemployment rate had shifted higher than expected in July and, as a result of that, caused many people to think that the Fed (Federal Reserve) may act more aggressively with rate cuts. We've yet to see a rate cut this year and now many are thinking that maybe they have to go earlier or maybe more aggressively. And that started to worry the market as you get this change in the carry trade initiative, which the BOJ and the Fed had been allowing due to the yield differentials. It has manifested in the market, it’s manifested across markets, and that's the volatility that we saw a week or so ago. We think that based on the short interest information that's available, as well as pundits in the market, that about 75% of this carry trade is cleared. And, so, we've seen the resulting stabilization, which has certainly been a benefit to markets in the last couple of days.
George: So, it sounds like there was a trigger outside the country of the U.S. It aligned with some of the data with a meaningful shakeout of some very crowded positions. So, from that perspective, the market is still kind of searching for this new equilibrium. But let's take a look. What's your take on the economy? What's the read-through for the U.S. economy and for monetary policy? Because while it may have started outside of the U.S., it's become a U.S. issue very quickly. And now many clients and ourselves, we're asking what is the impact on our economy?
Jamie: On the economy, specifically, to be honest, it's not significant when we're thinking about this specific set of volatility. The economy remains resilient. It's remained strong. The last GDP (gross domestic product) prints we've had in the second quarter remain very strong. And even the GDP now that we're getting from the Atlanta Fed and other pundits, it’s a 2.5% to 3% GDP rate for the quarter. I mean, that's remained very resilient. That said, I do believe we are operating in a bifurcated economy where those that are very, very well off or performing well are being very supportive of our economy while those on the low end are starting to feel the pain of inflation. A little bit more employment pressure and the ability to get jobs is certainly lower than what we've seen in the past year or so. That will weigh on certain parts of the economy, but when you look at it in its breadth and entirety, it remains very resilient and in a good spot. For monetary policy, certainly, we've capped out in rates. The next move for the Fed will be lower. Will that be in September? Certainly, the odds of that have improved in that we will likely see a cut of 25 basis points, but it's not set in stone yet. After the last couple of days, we've seen a number of Fed speakers come out and say, “Maybe it's not time yet. I don't have enough data yet.” That needs to be taken into account. So, those that are calling for 50 basis points may not see 50 basis points in September. However, the odds of 25 have increased, but we have five weeks until the Fed meeting and that's important. That meeting on September 18 will occur with a lot more data, so that's when we’ll be able to figure this out a little bit more. That said, we started an easing cycle and that will be supportive of the economy.
George: So, it sounds like recession’s on the rise. The Fed can pivot a little bit from its almost exclusive focus on inflation. Focus more on growth. The chances of a rate cut are going up, not down, along with those recession probabilities. So, I guess it sort of begs the question: Our clients want to know, how are we positioned? Were we set up for this? Have we been able to be proactive as volatility created opportunities? Are we taking advantage of that or were we maybe caught on the back foot? What's your sense of how our portfolios were positioned heading into this?
Jamie: Based on my discussion and review of portfolios, it's been almost advantageous for us to a degree because we had gotten more defensive. The reason we've gotten defensive is valuations. Valuations within corporate credit were on the tight end of ranges. We were seeing or feeling more pressure in certain sectors of the economy. And, so, we've been putting forth more of an up-in-quality trade, getting a little bit closer to home, if not slightly underweight credit, and putting that into other opportunity sets, whether it be ABS (asset-backed securities) or MBS (mortgage-backed securities). With that, the movement that we've seen in stretching out 15 to 20 basis points over the last week or so, we've been opportunistic buyers. We still like financials. We like utilities. We like TMT (technology, media, and telecommunications). And those opportunity sets were taken advantage of with new issuance that came out, as well as secondary market trades. So, we were able to take advantage of that and put forth some interesting opportunities in portfolios.
George: Being nimble in this kind of market is critical. And one thing that I think we as a firm, we as Allspring, we as a fixed income group, have reiterated is that this is not a set-it-and-forget-it market. This market requires a certain amount of active management. We're trying to preserve the cash flows in fixed income portfolios. When you get this kind of volatility, it presents opportunities. We want to be in a position to take advantage of it. So, it's great to hear that we were able to do that. It’s sort of a mini bout of volatility, but it does really help the portfolios. Now, let's talk a little bit about outside of the U.S. As you mentioned early on, this arguably started with a dollar-yen unwind but rapidly became a U.S. issue as well. When we look more broadly beyond the U.S., what type of opportunities do you and the team see? Whether we look in Europe or in some of the emerging economies around the world, has this presented some opportunities to take advantage of bond yields and certain credits outside of the U.S.?
Jamie: Oh, certainly. I think the biggest opportunities that have been presented aren't new because of this movement in volatility that we've had. We do still like some of the emerging market credits, whether it be in dollars or euros or local currency, especially in Latin America where you get more yield and more bang for your buck. Southeast Asia has some terrific economies with terrific growth, but there's not a lot of yield left in those economies, at least on a relative value basis when we think internationally and globally. So, really our focus has been more in the Latin American space with selected opportunity sets within Southeast Asia, Eastern Europe, and even parts of Africa. When we think about European credit, it traded pretty much in line with U.S. dollar credit over the past week or so. Month to date, we've moved about the same amount wider. Year to date, it has outperformed. And, so, we'd actually been taking down some of our exposures to European credit because it had outperformed the U.S. dollar markets. But there are always opportunities. And we do have the skill and research to take advantage of that. And we've done so. Just because we focused this last bit of volatility on the U.S, we took advantage of the European markets as well.
George: Well, Jamie, thanks so much for your thoughts. You've been able to kind of walk us around the world, up and down the yield curve, and across the credit spectrum in just a few minutes. So, really appreciate the comments. It sounds like the recent bout of volatility was clearly a wake-up call for investors as those global gears shifted from almost a near-exclusive focus on inflation to more awareness of risks to growth. And it's really, I think, worth emphasizing, worth stressing that our view, Allspring Fixed Income’s overarching strategy for all of this year, has been to number one, diversify duration; number two, preserve flexibility. It’s been really critical over the last couple of weeks. And then number three, be intentional with risks. Make sure that the risks are very closely aligned with your views. And that was important at the beginning of the year when we set those principles, and they're just as important today. And we think they're going to carry on through this year and into next. So, with that, Jamie, thank you so much for your time. It was a pleasure having you on SpringTalk and we really look forward to speaking with you again soon.
Jamie: Thanks, George. Appreciate it.
George: Always a pleasure. And for our audience, we hope to see you next time on SpringTalk.
Key takeaways
- Despite the recent uptick in broad market volatility, Allspring fixed income sees the economy as resilient and able to withstand some emerging pressure points. The likelihood of a U.S. recession has gone up, but not significantly so.
- The Fed is likely to cut rates in September but remains data dependent. Allspring expects a 25bp cut, the market expects 50bp and there’s a possibility Fed does nothing.
- Many Allspring fixed income portfolios moved “up in quality” as credit spreads tightened over the past 12 months. A focus on defensive positioning amidst renewed volatility served portfolios well: MBS and ABS outperformed corporate credit and high quality outperformed low quality.
- International allocations continue to provide diversification in global bond portfolios. Allspring research sees select opportunities in Europe and emerging market credits, whether it be in USD, EUR, or local EM-currencies. Latin America offers attractive yield.
- Allspring’s fixed income strategy of diversify duration, prioritize flexibility, and be intentional with risk, is as important today as it was at the beginning of the year.