The hard reality of policy divergence – with the ECB unleashing quantitative easing last week just as the Federal Reserve sits at the cusp of tightening – is causing global currency spasms and market angst.
Flexibility is critical for piloting the distortions of today’s bond markets pointing for example to the relative valuations causing 10-year US Treasuries to seem high-yielding by comparison to the rest of the world.
With 10-year Treasuries just north of 2%, their yields are currently higher than approximately 90% of the world’s government debt. In other words, even if Treasury yields go a little higher from here, they are still attractive compared to the rest of the world for a global bonds investor.
So, in this environment, where should yield-hungry global bond investors be looking for return and income?
The sector may no longer offer particularly ‘high yield,’ but everything is relative. In other words, compare the modest yields in European high yield to those on offer in other parts of the bond market.
More than a quarter (26%) of European government bonds are trading on a negative yield, more than half (54%) of German bunds are trading on a negative yield, with some 23% yielding less than the -20 basis points that marks the threshold for ECB bond buying eligibility.
In effect, this means the ECB will have to buy longer-dated government bonds, further flattening the yield curve at the longer end.
Other reasons to like European high yield are the solid fundamentals underpinning the sector and the tailwinds bolstering Europe, which include falling oil prices, the weaker currency-boosting exporters and the stimulative effective of the ECB’s ambitious QE bond buying programme.
The sector’s average credit quality is slowly improving, even surpassing the average creditworthiness of US high yield – the ability to pick amongst the best ideas in this sector is key.
Also, having the flexibility to account for volatile currency impacts is important.
A good example is Turkey, where I have traded in and out of the position in response to changing dynamics. I invested last year to capitalise on Turkey’s benefit from falling oil prices (they are a huge energy importer), but have since taken profits head of election year pressures that are likely to signal central bank cuts and a negative market reaction.
When the question on every investors’ lips is Fed versus the ECB, with two clearly diverging policies from arguably the world’s two most important central banks playing out with uncertain consequences in real time, it is important to take a macro-informed, unconstrained approach to the global bond markets.
