WM issue 5

Fed began raising rates, short term USD bonds were hit
first, not acting as safe havens in this turmoil. All tenors
are suffering with 30yr performance YTD touching a
massive -23.8%, while 10yrs Treasuries are retreating by
-12%. Broad Investment Grade corporates are -12.8%
as of 10/6 with the US high yield outperforming at -9%.
Emerging markets are following with sovereigns dropping
by -15.6% while corporates behaving more defensively
at -11.4%. European bonds are following, with
sovereigns retreating by -12.8% while broad investment
grade euro corporates are down by -12.8%.
Christos Elafros: What is your outlook for fixed income
asset-class overall and sub-asset classes for the
rest of the year?
Platon Chaldeos: While most Fed actions are discounted
and have been driving US rates so far, ECB actions
are now unfolding and ready to offer more pain through
higher euro rates. Nevertheless, there is always the fear
of a policy mistake and that doing too much tightening
might drive the economy into a recession, since this
inflation episode is being driven by supply chain disruptions.
As a result, bonds find themselves in a wedge
between stagflation and the prospects of a hard landing.
A lot is priced in the USD curve as the Fed has been
more vocal managing expectations and the treasury curve
has reacted to that. After the FED delivered a 75 bps in
its June meeting the market is pricing in an additional
200 bps by year end. We view that the longer-term rates,
especially the 10yr trading range, will remain at 3.0%-
3.5%, while the damage done on the short end of the
curve is excessive, rendering the 2-5yrs area attractive.
They are considered a safe pick since their duration risk
is low.
Corporate bond spreads have widened as the higher cost
of borrowing is expected to impact bond issuance and
balance sheets. Currently the impact is being felt to a
greater degree on the higher yielding corporate bond
spectrum. The 10yr Baa USD bond spreads have approached
240 bps from last year’s lows of 160 bps and
are now trading around 200 bps amidst restrained global
issuance. US high yield spreads have propelled to 540
bps from a low of 217 bps last year. We continue to see
very little value in both the high yield and high grade
bonds at these levels as the prospects of a recession is increasingly
becoming a probability.
At the ECB meeting, the termination of the APP programme
was announced, with 25bps tightening in July
to be followed with 50 bps in September. European
periphery, which was the main beneficiary of the PEPP
programme, is now exposed to volatility and higher energy
prices, with spreads widening to their highest levels
in 2 years. It is especially painful on Italy and Greece,
which are among the most indebted economies. Spread
between Greece vs Italy remains steady at 50 bps. Indications
are that the periphery will be hammered unless the
ECB presents a credible bond spread control mechanism.
High energy prices and recession fears have affected
Core eurozone
sovereign yields can
now be a part of our
investment platter, as they
are decisively moving into
positive territory
PLATON CHALDEOS
European corporate and HY spreads. Their YTD underperformance
is mainly due to the core rate moving upwards and secondarily to
widening. Nevertheless, there is room for underperformance in case
economic growth projections falter and equity volatility elevates.