The Quest for Yield

Alexis De Mones, ABN AMROÆs global product specialist for fixed income products, is looking cautiously at the global debt markets in the US and Europe, but is keeping an optimistic eye on Asia's growing debt markets.
Looking at both G3 and domestic issuance, what is your overall outlook for the debt capital markets?

In the main markets, we have a pretty cautious outlook on fixed income valuations. In the US, we expect the Federal Reserve to raise another couple of times and we anticipate a 5% breach in 10-year yields toward the latter part of the year.

Overall, the market has already priced in future rate cuts, so the risk lies in the economy surprising on the upside.

In Europe, We expect the European Central Bank to tighten two to three more times this year. Considering the numbers coming out in terms of consumer confidence and business sentiment, the short part of the curve should be cheaper. So we believe that two-year rates should be higher then where they are now.

We see the yield curve in Europe flattening this year - something we refer to as æbear flatteningÆ. The short end of the curve is rising, while the longer end is not moving too much.

In terms of Asia, we're pretty comfortable with the outlook for the emerging markets asset class as a whole, although we think tvaluations are pretty full and somewhat punchy. But we believe the economic fundamentals warrant continued optimism.

In a global environment of moderate yields, you'll continue to see the search for yield as a major theme in the global capital markets. This means we'll continue to see good demand for assets and don't expect to see emerging market spreads to blow out this year.

We're currently overweight on Latin America and in Asia we're pretty positive on India and China over the coming year. In considering local currency markets, it's very important to evaluate the local currency regime.

For example in Hong Kong and China, you need to take into account the US dollar peg, The currency peg underpins a strong correlation of interest levels between the US and Hong Kong or China. We see better opportunities in markets like Indonesia where there's a floating currency regime. We really separate our analysis between markets that have a floating currency and those that have a pegged currency.

Why is your focus more orientated towards the Latin American market at the moment?

In terms of hard currency global emerging market debt, the highest-yielding assets tend to be in Latin America. The political and macro-economic environment there really provides better opportunities for yield. Of course it provides more risk, but also better opportunities. The macro-frame work and political environment seems to be much more stable throughout Asia. You have the odd exception, like the Philippines. But we tend to play those much more tactically.

So you believe that the Asian international bond market is currently priced too expensively?

It's been expensive for a very long time, and I donÆt expect this to change in the near term. All global markets are pretty tight, but you need to analyze your markets in terms of fund flows and see where investors are trying to position their capital.

We believe there are opportunities in the high-yield space in Asia. We believe this irrespective of spread tightness. There's still an excess of liquidity in the international financial markets and a quest for yield. This will continue to be the case as long as liquidity is plentiful and indications are that levels will remain fairly abundant.

So we're positive on the Asian debt capital markets and have been trying to exploit the quest for yield theme, which has driven emerging markets for the last couple of years.

What/s your outlook for the Asian high-yield markets?

Corporate high-yield issuance is still a relatively new market in Asia and isn't very deep. However, we're pretty excited about the development of that market. Right now though, the local currency market is still a sovereign game. Corporate issuance has picked up somewhat over the past year or so, but it's still fairly limited so to speak.

We are monitoring that very closely. We're investing in local currency markets in a number of countries throughout Asia, but our investment in the corporate sector has been limited. We'll be looking to get more involved in this market as it deepens over the next couple of years.

Looking at the further development of high-yield and corporate issuance, what are you hoping to see over the next year?

There are three key issues that need to in place for the further development of these markets - liquidity, yield curve construction and the transparency of corporate information.

We've seen a lot of development in terms of sovereigns building up the yield curve. A number of countries now have a series of benchmarks all along the curve.

That will of course drive pricing transparency for corporate issuers along the curve, although corporates tend to issue more along the short end of the curve.

Liquidity levels have also improved, helped in part by the pan-Asian fund now initiated by a number of Asian central banks. That's a strong positive. On the back of that we're hoping to see a deepening of liquidity in the local currency markets.

Transparency and corporate disclosure has been pretty good, but could still be better.

So what are ABNÆs overall investment strategies, in terms of credit management?

In Europe, we have a tactical small short in the Euro curve. We believe the five-year is the weakest point in the curve. We have two flattener positions in the Euro curve as well. In our view, the 30-year will perform better than the five-year. So we have a five-year /30-year flattener as well as a ten-year /15-year flattener. So we expect to see a flattening of the Euro curve as the ECB tightens rates and the long end remaining well supported.

We also have a tactical short in the US dollar curve. The market has already priced in a recessionary episode in 2007 and we believe the economy will not roll over as a lot of people fear. Of course, we believe the inversion is an indicator of a slow down in the US economy, but there is no mystery there.

We donÆt believe the slowdown will be as bad as the fixed income markets are indicating. We are slightly negative on US fixed income at the moment. The economy is expected to slow down, but not to the degree most people believe and we do not see the Fed cutting rates in 2006.

We also have a flattener position in Japan. We believe the long-end is well supported, because of structural demand for long-dated assets for liability management reasons. We see the ten-year as vulnerable, and were somewhat surprised that it did not sell off more than it did in 2005. So we have had a tactical shorting in this market, but the flattener is the best quality trade that we have on.

Within the next six months, we expect to see the Bank of Japan end its policy of quantitative easing, so there will be a real positive interest rate in Japan in the second half of the year. This should drive the equity market, but wonÆt be good for the fixed income market, so we have a short duration in Japan as well.

Share our publication on social media
Share our publication on social media