Picking Spots in Bond Markets

April 1, 2020

5 minute read

by The editor's desk, AGF Management Ltd.

Members of AGF’s Fixed Income team give their latest thoughts on the asset class in this week’s crisis roundup.

Tristan Sones, Vice-President and Portfolio Manager, Co-Head of Fixed Income, AGF Investments Inc.

We are continuing to see a massive divergence in the performance of emerging market (EM) countries on the back of three main factors: Their COVID-19 response and implementation; their capacity for fiscal stimulus; and the economic impact of the oil price collapse. Some oil-exporting countries are already trading very distressed with some going so far as to suspend payments and ask bondholders to prepare for re-profiling negotiations. Downgrades are accelerating with pressure on Middle East oil exporters and South Africa finally being reduced to junk status. Bond prices are adjusting quickly, although trade volumes are depressed. Some EM funds are being forced to sell to meet redemptions whereas others are starting to dip their toe in and add exposure at levels much more attractive than just a couple of weeks ago. New issuance has been light, but extremely well received, so there is cash out there looking to be put to work. This environment very much benefits active management, a trend that is likely to continue in the quarters ahead.

Tom Nakamura, Vice-President and Portfolio Manager, Currency Strategy and Co-Head of Fixed Income, AGF Investments Inc.

Currency markets continue to reflect ongoing uncertainty and concern about the global pandemic and its impact on the global economy. Recent measures by the U.S. Federal Reserve have helped to increase liquidity and the extreme demand for U.S. dollars that we saw in the first half of March has subsided, although it remains at elevated levels. More recently we have seen some degree of normalization in the pecking order of currencies in risk-off episodes, with the Japanese yen and Swiss franc appreciating against the U.S. dollar and the Canadian dollar lagging currencies like the Euro and British pound. On more positive days for risk, markets have been more focused on reversion to the mean, rewarding currencies that have underperformed the most, without much regard for relative economic impacts, nor the costs of substantial fiscal and monetary policy.

Andy Kochar, Portfolio Manager and Head of Credit, AGF Investments Inc.

The COVID-19-induced panic has resulted in a significant and, yet, much needed re-pricing of global credit markets. As is the case in every economic cycle, recessions are associated with a breakdown in credit markets resulting in corporate credit weakness, a pickup in default rates and broad re-pricing of risk. A recession also sows the seeds of an incoming recovery where credit starts to look attractive once again after the system is cleansed of corporate defaults. As it stands today, corporate credit markets are fully baking in a garden variety recession that tends to last, on average, about six to eight months. Looking out 12 months from now, and adjusting for expected default, we believe there is significant value in credit markets, especially in the upper echelons of the quality spectrum. As a result, it may benefit investors to avoid companies with acutely weak balance sheets and increase exposure to those that will come out of the recession in much better shape. We are actively looking for opportunities in the investment grade space as well as the best of the high-yield market.

David Stonehouse, Senior Vice-President and Head of North American and Specialty Investments, AGF Investments Inc.

The Bank of Canada cut overnight rates to the effective lower bound of 0.25% on Friday, the last of the major western central banks to do so, and we expect 0% interest rates for a prolonged period. After intense forced buying a couple of weeks ago due to hedged fund positions being unwound, the volatility in government bond markets is gradually settling down as central bank facilities have eased dislocations in those markets. Yield curves are steepening as investors re-allocate funds from government bonds to other assets and bond prices normalize. After inverting before recession, the yield curve typically steepens into recession as short rates fall with central bank cuts and long bonds start to reflect an eventual rise in inflation and economic activity. However, in our view, yields are unlikely to rise as substantially as historical norms of 150 to 250 basis points of steepness between two-year and 10-year Treasuries. This is based on anticipation that at least some central banks will implement yield curve control to keep borrowing costs more manageable. In short, we believe the low interest rate theme of the past decade plus remains intact.

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