14 Jul 2021
09/07/2021 | Tim Foster, Portfolio Manager
So here we are, officially in the second half of the year. The macro-economy has shown strong growth, but with the best now behind us. Central banks must now make the best of a tricky position, as they attempt to guide the slowing of quantitative easing (QE) programmes and eventual rate hike(s) against a slowing growth and inflation backdrop.
The fallout from the FOMC’s recent meeting was intriguing, with the market bringing forward the pricing of eventual rate hikes, whilst reducing the total number of hikes priced in. The hawkish shift in the Fed’s dot plot has failed to disturb the latest bond market rally, as it remains highly unlikely the peak of the last cycle in rates will be reached. The fund has benefited from the fall in government bond yields, particularly US Treasuries, in a continuation of the move lower that began in March.
Apart from the tightrope walk facing the Federal Reserve, what else is on our radar? We are keeping a close eye on the US Administration’s spending plan progress, the upcoming debt ceiling (suspension ends at the end of July) and further out the possibility that Jerome Powell might be replaced as Fed chair in February next year, just as tapering will be starting.
In addition, while there are positive signs that the expected rotation from goods to services spending is happening, for example in credit card data from the US banks, we fear that the incremental economic benefit from further unlocking could well disappoint. The UK shows the way here with the Bank of England’s CHAPS payments data suggesting a slowing of activity in recent weeks, and it seems the Delta variant is likely to continue its spread across the EU in the near term.
Elsewhere, credit markets continue to be very active and the primary market has been a hot topic of late. We have seen strong supply year-to-date, with record or near-record supply in US high yield and investment grade, as well as European high yield.
This is something of a surprise, given that many issuers rushed to refinance and boost their liquidity last year, but low yields and plenty of willing buyers are proving a compelling combination for company treasurers. In the high yield space, we are also likely to see a continued high level of LBO and spin-out activity, with cash waiting to be deployed at buyout firms and the possibility of capital gains tax increases in the US boosting the number of willing sellers of companies.
The supply of green, social, sustainability and sustainability-linked bonds has also accelerated, and these accounted for a record 17% of global issuance in June. This has included a notable increase in labelled bonds from high yield issuers, which is encouraging evidence that sustainability considerations are growing in importance for smaller companies and those without public equities. While the primary pipeline may not run quite as hot as the first half of the year during the two remaining summer months, this pace of supply continues to throw up some interesting alpha opportunities for us, for example in the consumer sector. Valuations are compressed though, so we remain cautiously positioned in credit overall.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. The Fidelity Strategic Bond Fund can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.