Bonds (October 2016)

Fed's Delay a Boon for Credit Markets

"With accommodative monetary policy globally, bonds should continue to deliver performance over the coming months. However, we expect returns to be driven more by income than capital appreciation."

- Vasu Menon, Senior Investment Strategist, Wealth Management Singapore, OCBC Bank; Member of OCBC Wealth Panel

  • After a modest decline early in the month, the Fed’s decision to put off a rate hike led to a rally in global bond markets. Emerging Market (EM) produced its seventh consecutive positive month.
  • The JPM CEMBI, a global, liquid corporate emerging markets benchmark that tracks U.S.-denominated corporate bonds issued by emerging markets entities, was up 12.1 per cent with High Yield gaining 16.7 per cent and High Grade up 9.3 per cent. EM bond seem on track to eclipse the 12.5 per cent return of 2010, the second best year on record, barring unforeseen calamities.
  • Within Developed Markets, U.S. High Yield managed to eke out a modest 0.1 per cent gain while Global Investment Grade declined 0.4 per cent.
  • Returns in Latin America have been both significant as well as broad-based. As such, valuations are no longer as attractive and we advocate a more neutral Asia/CEEMEA/Latin America top-down strategy. Our focus will be on specific Country, Sector and Individual Credit bets as the primary driver of performance for the remainder of the year.
  • Within Asia we would take a more neutral stance on High Yield given that spread levels have tightened to around ~500 bps, well below the 5-year historical average of ~700 bps. We would also maintain our Underweight in Asian Investment Grade (particularly Korea and Malaysia) where spreads often trade inside of comparably rated Developed Market Credits.
  • We expect the spike in High Yield issuance to continue in October as issuers have found a receptive audience in the current ‘Hunt for Yield” environment.
  • While we remain constructive on the EM High Yield asset class in general, investors should be both circumspect and selective as this risk-on environment tends to result in increasingly lower quality issuers.
  • As such, we would maintain our preference for higher quality names (‘BB’ and above) despite less compelling valuations. Although the BOJ and Fed actions should be supportive for long dated bonds in the short-term, investors should be mindful of duration risk on an increased likelihood of a December hike.
  • An accommodative monetary policy globally should enable Fixed Income assets to continue to deliver performance over the coming months.
  • However, we expect returns to be driven more by income than capital appreciation. Given current valuations within EM, we are positive on EM High Yield along with U.S. and EM Investment Grade.