Fixed-income investors rode a roller-coaster in 2019, as monetary policy at the world’s major central banks switched from tapping the brakes to hitting the accelerator. The volatility that ensued ricocheted throughout fixed-income markets around the world. Is a similar ride in store for 2020? InvestmentNews Content Strategy Studio recently spoke with John Lovito and Charles Tan, co-chief investment officers for global fixed income at American Century, to learn their views of what investors are likely to see in the coming year. Highlights of the conversion follow:
InvestmentNews Content Strategy Studio: Let’s start with the big picture — where do you see interest rates going in 2020?
JOHN LOVITO: We expect 2020 to be a less dramatic year than 2019, when U.S. monetary policy reversed from tightening to easing and Europe saw a big drop in rates. That’s not likely to be repeated in 2020. In the U.S., we believe rates will be more range-bound than directional, with yields on the 10-year U.S. Treasury between 1.5% and 2.00-2.25%. We see a steady U.S. economy ahead and more stability in Europe, with China deleveraging in a controlled manner.
INCSS: Where could potential problems pop up?
Charles Tan: It’s still not clear whether we’re out of the woods and heading to some kind of initial deal on global trade, or whether the weakness in manufacturing will win out over the strength of the consumer or vice versa, so those are two areas that could prompt a rise in volatility.
John Lovito: We also have to remember that as we get deeper into 2020, election-related politics will become more important. Depending on who the Democratic candidate turns out to be and depending on the likely Red/Blue composition of Congress and the White House, markets will adjust to what they see coming in the way of regulation and taxation, among other policy issues.
INCSS: What about the impact of negative interest rates? Do you see those coming to the U.S.?
John Lovito: Certainly in most of Europe, negative rates and very aggressive monetary policy will be around for a while. To be sure, many would like to see European stimulus come from the fiscal side, but, with the exception of France, that seems unlikely given the strong cultural forces against deficit spending. So Europe is sort of stuck. While many Europeans believe negative rates won’t do much to spur economic growth, they fear that higher rates — even those extremely low by historic standards — would slow economic activity on the Continent.
Charles Tan: Here in the U.S., the Fed has made it clear that negative rates are not part of its policy. But, since the market, the economy and demographics — not the Fed — drive longer-term rates, there is always the possibility that we could see bond yields dip into negative territory. The low rates we’ve had for some time, coupled with gains in technology, have created overcapacity. At some point, as monetary policy becomes more and more stimulative, instead of being inflationary, it actually becomes deflationary, which poses entirely different economic problems.
INCSS: Given this backdrop, where can retail investors find returns?
Charles Tan: Certainly that’s a challenge now that risk-free returns are gone from the market and spreads are tight. But there are selective values out there, and on a relative basis we like sectors exposed to consumers and housing, because consumers are in good shape and the U.S. housing market has been steady. We like the single-family rental part of the commercial mortgage-backed securities market and also are finding value in securitized loans in the time-share area, where borrower’s credit quality are generally high and there are structures that protect investors.
John Lovito: Overseas, we see value in local currency emerging market (EM) sovereign debt. We believe the more stable economic outlook for 2020 and the stable U.S. dollar will set a better backdrop for EM currencies. Since the rise of populism that we’ve seen over the last five years, in several EM nations, is not going away, we’ve been careful in where we have invested—and have avoided Chile, Argentina and other Latin American countries. In hard-currency countries, we generally prefer high yield credits over investment grade credits.
Charles Tan: The muni market, which was on fire in 2019, should continue strong in 2020. Municipalities generally are in good fiscal shape, and investors like the after-tax yield that munis can provide. What’s more, supply has been declining, which creates very strong technical dynamics.
INCSS: What advantage does active fixed-income management provide in the environment you see
Charles Tan: Investing in an equity index represents exposure to growth and value creation. Investing in a bond index represents exposure to liability. Since credit quality generally has been deteriorating in recent years, fixed income index investors increasingly hold credits of deteriorating quality; the passive approach is taking them to the wrong place.
John Lovito: Another point to note is that despite some ups and downs, the post-crisis decade has been a fairly benign period of declining interest rates and improving credit spreads — a good time for one-way trades and a passive, index-based approach. But even in the fairly calm period we see for 2020, volatility and unexpected events can occur. At such times, looking at each issuer analytically becomes more important, as does adjusting a portfolio based on changing circumstances. The post-crisis world also has seen declining bond market liquidity. In times of stress, the ability of skilled active managers to trade opportunistically, and not mechanically, can add great value.
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