The global macro environment in 2021 may be towards the peak of the post-Covid 19 recovery, suggests Managing Director, Chief Investment Strategist, and Head of Global Bonds for PGIM Fixed Income, Robert Tipp. The success of his team in predicting market developments has been recognised by PGIM Fixed Income’s receipt of the Asia Asset Management 2021 Best of the Best Awards for Global Aggregate Bonds (10 years) and US High Yield (3 years).
Fundamentals and fixed income
Post the initial impact of Covid-19 and the ensuing market shutdowns, Tipp continues, the “avalanche of stimulus”, monetary and fiscal, has taken the global economy through the depths of shutdown to “the vaccine and rapid growth recovery stage”. He feels that the bond market is now fearing a resurgence of inflation.
The concerns over inflation, along with expectations for continued strong growth, Tipp suggests, “may push up long-term rates over the course of 2021, especially if the current stimulus is followed by additional stimulus, possibly even a multi-year infrastructure program.” All the same, with “more moderate longer-term economic prospects that will exist post stimulus”, he sees the current high rates “as a temporary overshoot of fair value caused by market participants extrapolating unrealistically the current robust pace of growth into the distant future”. Looking forward to 2022, he adds, “rates are likely to crest” during the year, or even earlier, and then pull back “as growth and inflation pressures pass their high points”.
Tipp expects to a large degree an eventual return to conditions much like the pre-Covid-19 period. Just as inflation failed to hit its target then, he explains, “the same configuration is likely to emerge post-Covid as the secular fundamentals of ageing demographics and high debt burdens reassert themselves with a vengeance.” In any case, he avers, “long-term rates are likely to remain low”, and he expects to see German bund yields remaining well below zero, and the US Treasury yield eventually dropping back towards 1%.
Currencies, negative yields and opportunities
No proponent of negative yields, Tipp views these as “a seemingly futile attempt” by certain countries to achieve their inflation targets. Although these countries may strive to use these to stimulate borrowing and growth, he warns that “they may over the long term unwittingly depress their populations’ income and investment returns through this confiscatory regime – a form of financial repression.” He expects the US Fed to continue to avoid going down this route. Only in what he describes as “the unlikely scenario” of negative rates becoming the international norm does he see the Fed following this path, “to avoid a potentially pernicious currency appreciation”.
The currency outlook, meanwhile, Tipp expects “to become choppy in the quarters ahead”. The US dollar may have lost its allure during 2020 with “the drop in US rates relative to the rest of the world”, but he feels that much of that wholesale drop may already have passed. In this kind of unpredictable environment, he adds, “while global diversification among bond markets is likely to remain attractive, doing so on a hedged basis may prove more efficient than unhedged investments.”
Finding fixed income favourites
Although not every macro factor may positively align over the next 12-24 months, Tipp cautions, he still sees “significant opportunities to add value through active management” resulting from the current situation, especially due to a confused market outlook ahead. Those opportunities will persist in spite of “the generally low level of rates and historically tight credit spreads”, he continues – but not every market player will be able to perceive and capture them.
In Tipp’s eyes, the post-Covid recovery will play out unevenly across the globe. Astute bond investors will therefore be in a position to exploit the resultant “avenues for adding value through inter- and intra-country yield curve positioning”.
He also sees persistent opportunities for value creation in sector allocation and issue selection, with “pockets of relative value in securitised products, investment grade and high yield corporates, as well as both local and hard currency emerging markets debt”. That said, he adds, the same bouts of volatility and illiquidity seen in past years will recur, “increasing the need for a deep research basis for all investment decisions” – a research base which PGIM Fixed Income has amply demonstrated it possesses.