The shift to monetary accommodation in 2019 produced an unanticipated windfall for fixed income assets. If global reflation strengthens in 2020, opportunities in a number of out-of-favour industries – such as energy groups and auto manufacturers – could prove appealing.
Alarmed by spreading signs of global economic weakness, key central banks changed monetary policy direction in 2019, cutting interest rates and reviving or expanding quantitative easing (QE) programs.
The policy shift has been both widespread and dramatic. While 2018 saw approximately two interest rate increases globally for every cut, this trend flipped in 2019, with 91 rate cuts worldwide but only 16 rate hikes through the first three quarters of the year. Clearly, central banks have been making a synchronised effort to expand liquidity to support the global economy.
While we do not believe the US Federal Reserve is likely to cut rates in 2020, we expect global monetary policy to remain supportive as the European Central Bank and the Bank of Japan continue QE.
Navigating a negative yield world For bond investors, the shift to monetary accommodation in 2019 produced an unanticipated windfall, with virtually all global fixed income sectors delivering solidly positive returns. Yields dipped into negative territory across a wide spectrum of sovereign issues, producing capital gains at the long end of the yield curve. As for corporate bonds, the investment grade and high yield sectors both delivered double‑digit returns in 2019, as investors reached to lock in yields. Emerging market (EM) debt, including EM corporate credit, also performed well despite a stronger US dollar, as easing inflationary pressures gave some EM central banks room to cut interest rates.
While the pool of negative‑yielding debt shrank somewhat in 2019’s second half as bond markets recovered from a late‑summer flight to quality, it still accounted for more than US$13trn in bonds outstanding – 24% of total global market value – as of the end of October 2019.
Potential credit opportunities in reflation Lingering concerns about the global economy have led many high yield investors to remain cautious about troubled companies and industries.
However, if global reflation strengthens in 2020, we think investors may want to consider selected opportunities in some disfavoured sectors – such as energy companies and auto manufacturers – where credit spreads remain relatively high. Overall, credit quality in the high yield universe has improved since the 2008-09 global financial crisis, which we think could provide a cushion if the global economy falters again in 2020. If we were to go into recession, we believe the overall default rate in high yield could be lower than it was 10 years ago.
The double-edged duration sword The sharp declines in bond yields seen in 2019 have generated downside risks for 2020. Duration is a double‑edged sword, and even a modest rise in bond yields from current low levels could negatively impact total returns.
If 2020 economic data catch up with expectations, we think the yield on 10‑year Treasuries could move north of 2%, maybe as high as 2.25% to 2.5%. This is not enough to cause massive pain, but further out on the yield curve – for example, the 30‑year US Treasury bond – a move to a 3% yield could cause losses on a mark‑to‑market basis.
In such an environment, we think short‑duration high yield credit instruments are likely to offer the more attractive risk/reward combination in 2020.
The Importance of going global A global high yield strategy can take advantage of pricing dislocations caused by unsynchronised credit cycles, relative value disparities, and geopolitical events. There are also potential diversification benefits from investing globally.
Both the European and EM high yield markets are less mature and are not followed as closely by investors as the US market. For example, dedicated EM corporate investors make up only 5% of this market. Such low levels of dedicated ownership result in a more inefficient market and, in our view, present more opportunities for skilled active managers to take advantage of pricing dislocations and attractive relative value.Overall, we believe the enhanced diversification of a global high yield strategy can help overcome periodic bouts of changing market sentiment toward particular issuers, countries or regions.