As cash loses some of its appeal to investors with interest rates beginning a much-anticipated decent, Matthew Rees, head of global bond strategies at LGIM, hopes some of that flow will be redirected to fixed income.
Finally, he says, “you can get a yield that’s no longer boring as hell”.
In recent years, many investors have felt comfortable straying away from “boring” bond investments due to a strong US equity market. Rees said this has created an “element of FOMO” among investors who have seen the rapid appreciation from the magnificent seven and wider US market.
Transferred to fixed income, Rees said this has pushed investors towards credit assets with more attractive yields instead of a risk-averse government bond.
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“One of the comforts I’ve had about being quite long in credit is I do think there’s a second wave (coming). Most of the wave we’ve seen so far has been more institutionally driven; big pension funds and big insurance companies moving into fixed income,” Rees said.
“The second wave, I think, does come as people rotate out of money markets or cash funds. Some of it will be into fixed income, most of it will be equities. Fixed income investors will always hope it will come towards us, but come on, we are a boring asset class. People still want to make 15-20% which is, at the time, what people think they can get in equities. But some of that will come to fixed income.”
Rees said while he hasn’t seen the transition pick up yet, as people realise that rate cuts have arrived and cash yields are no longer appealing, inflows will increase. To the end of July, bonds have experienced $16.1bn in inflows while equities have drawn $22.2bn, according to research from the Bank of America.
Although the Bank of England opted for its first rate cut of the year in August, the US Federal Reserve has so far maintained. While markets have priced in a September cut for the Fed, a set of unemployment data at the beginning of August spooked markets into a selloff.
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“It was over dramatised totally. We had actually increased the shorts in credit default swaps (CDS) a week and a half before that, partly because the earnings season was being attacked up to some degree, and the Magnificent Seven dominance was being questioned. So we put a short on in the US CDS market, and then two days before the unemployment number, put a short on in the European CDs index. That was partly because of the narrative that had started to increase about recession.”
Rees said before the release of the data, he had set out his own guidelines of what would make him change his positions based on payroll numbers. He believed if the payroll number was between zero and 50,000, then people should have concern about recession. However, the payroll number was 114,000.
“To me, that’s not bad enough. And there’s some seasonals within there as well. So I think it was a big overreaction, exacerbated by some liquidity.”
While Rees began June with an average duration of about three years, by the end of July he had hiked duration up to between six and seven years. Following the market’s August wobble, he reduced again to about five years.
“For the fund as a whole, we were much lower in our duration than many of our peers, because we weren’t as confident a recession was coming, and we can’t predict inflation. We don’t think anybody should do and until we had two to three prints of inflation going down, particularly in the US, and the market had less concern about it, that has given us some confidence to increase our duration.”
In watching for a soft landing for the US, Rees has also kept an eye on credit card delinquency data. He said most banks have reported that delinquencies have peaked and are no longer increasing.
“Banks are always going to talk their book to a certain degree, you have manage being overoptimistic, but it did show me that the consumer credit card problems in the US are amongst the lower 50% of the income range,” Rees said.
“Unfortunately they’ve exhausted their excess savings, but the better off have still got loads of money and are still spending. If they’re spending, I think the US economy is fine. That’s why I’m less worried about near-term US recession.”
