As we approach the end of the second quarter of 2021, we checked in with Althea Spinozzi, Fixed- Income Strategist at Saxo Bank, to find out more about where the fixed-income trading market is headed and what factors influence its developments. In this short interview, the market expert illustrates how the fixed-income market has evolved over the last year, highlights the latest trends set to impact the industry and gives us an indication of what to expect next.
How would you describe fixed-income trading for the first half of 2021? What differences do you see with respect to the same period in 2020?
The biggest difference between this year and 2020 is the fact that the bond market lacks options due to extreme risk premia compression. While at the beginning of 2020, USD-denominated investment grade bonds were providing a yield of 3% on average, now they pay only 2.3%. High-yield USD corporate bonds are now offering a yield of 3.9% versus 5.2% in January 2020. Real yields have plummeted into negative territory with inflation running at 5%, making the bond market even more challenging. Investors have to choose between credit quality and duration knowing that they may lose money whatever they pick because interest rates are going to rise, putting pressure on both strategies. Currently, high-quality assets carry the highest duration making them more vulnerable to a rise in interest rates.
What makes the fixed-income market attractive?
The fixed-income market remains attractive because it enables investors to lock in a specific yield for a chosen maturity. Therefore, it removes a degree of uncertainty surrounding the risk/return profile of one’s investment. Yet, the challenge in this environment is to find instruments that enable investors to create a buffer against inflation. With the Consumer Price Index being at 5%, that type of yield can currently be found only within junk bonds.
Which factors are most likely to influence the fixed-income market for the second half of the year?
Monetary policies and inflationary pressures. We expect central banks worldwide to pull support gradually as the economy reopens. However, inflationary pressures could accelerate the move. If elements suggest that inflation will be more persistent than what the Federal Reserve led the market to believe until now, the rise in yields could be abrupt.
Have you noticed any new trends emerge since the beginning of the year?
We have noticed that investors are cutting on exposure to US Treasuries in their portfolio because they feel that they have lost their “safe-heaven” properties.
Have investor profiles, preference and behaviour changed since the end of 2020?
Compared to the end of last year, investors are more careful at cherry-picking risk because they understand that they might need to hold those assets for a long time amid an interest rate rising environment. Thus, they want to be comfortable with the credit risk that these instruments carry. Moreover, we see fewer investors churning positions because their assets may have increased in price, but it is challenging to find good value elsewhere.
What new geographical areas have emerged in terms of fixed-income trading?
We see investors wanting to be as close as they can to the economic recovery. Thus, we see a preference for US corporate bonds versus the emerging market. Yet, sectors such as energy have been a favourite regardless of where the company is based. We expect this trend to continue until the shocks from the COVID-19 pandemic have waned.
Where do you think the market is headed next?
We believe that the market is headed towards a new paradigm where we will see inflation above levels that the market is normally accustomed to. As a consequence, US Treasury yields will need to stabilise at much higher levels. While in the mid-term, a repricing will be painful, it will bring much better opportunities in the long run.
Althea Spinozzi, Fixed-Income Strategist at Saxo Bank.