16 Jun 2021
04/06/2021 | Claudio Ferrarese
Fidelity Strategic Bond Fund portfolio manager Claudio Ferrarese outlines why fixed income investors shouldn’t be overly concerned about the reflation narrative currently driving financial markets. He also outlines how the portfolio is positioned to capitalise on reopening opportunities, particularly with an eye towards sustainability considerations.
The second quarter of 2021, so far, is proving to be anything but dull for investors. On the economic data front, worse than expected US unemployment data was swiftly followed by the sharpest year-on-year rise in the US consumer price index (CPI) since 2008.
US Consumer Price Index (CPI) for all urban consumers
Source: Fidelity International, Bloomberg, historical data to 30 April 2021. ‘Market pricing’ uses inflation swaps and takes the one-year inflation breakeven rate n years forward.
Both prints served to highlight the complexity of measuring the reopening of economies, whilst the latter also reinforced the reflation trade as the front-runner for theme of the year. Higher than usual goods spending and some supply bottlenecks, for example in semiconductors, have driven commodity prices and goods price inflation up.
However, it is called the reflation “trade” for a reason and we would urge caution in reading too much into the reflationary theme from here. While there is still some potential for a sustained increase in services prices, a lot of the goods price effects are one-offs, with supply-side disruptions likely to be temporary in nature.
We could be mistaken if fiscal expansions were to outstrip expectations over the longer-term and the Phillips Curve were to steepen towards the shape we had 30 years ago. Yet we find it hard to see both happening, and longer-term it will be difficult to sustainably break away from some of the structural drivers of disinflation: an ageing demographic, technological advances and record levels of debt to GDP (which has increased markedly over the past year).
In the meantime, there seems to be quite a lot of inflation priced into markets already and US Treasuries have accordingly been more rangebound of late, with the US 10-year trading in a narrow 20 basis point range quarter-to-date.
Another theme we have been considering is the reopening of various economies around the world. Having added to our developed market corporate bond exposure in the first quarter (in an attempt to benefit from the expansionary backdrop), our strategy more recently has been to trim, rather than add, credit risk. Nevertheless, working with our analyst team, we continue to find selective opportunities to tap into the ongoing reopening theme, but with an eye on sustainability.
For example, Rexel, a French distributor of low and ultra-low voltage electrical products, recently issued a sustainability-linked bond with a coupon step-up and increase in call price if they do not meet one of two sustainability targets.
As we have touched on in other recent Strat snippets, Sustainability-linked bonds are a relatively recent and much less established (not to mention understood) form of sustainable debt instrument, but one we find broadly appealing because of the focus on outcomes rather than inputs. The flip side is that the targets and coupon step-ups attached to them need to be sufficiently ambitious, as well as credible.
In Rexel’s case, we like that the company aims to reduce the carbon intensity of its product portfolio by 45%, and reduce carbon emissions from its operations by 35%, by 2030. We also felt this was an opportune way to get exposure to the recovery in the European construction market, as well as the development of smart buildings and homes in the capital goods sector.
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