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Market View I Dickie’s View July 2022

 

Richard “Dickie” Hodges, Manager of the $3.1bn Nomura Global Dynamic Bond Fund, provides his view of the fixed income market environment:

Published 12th July 2022


Key Takeaways

  • Our overwhelming sense is that risk markets will continue to be vulnerable until such time that the Federal Reserve confirms they have raised interest rates sufficiently to control inflation.
  • We strongly suspect that, when they do make this confirmation, the rebound in risk assets will be significant and rapid. However, its announcement is unlikely to come for a number of months.
  • In the meantime, the Federal Reserve and their global peers (with the notable exception of the Bank of Japan) seem determined to orchestrate a recession; driving down demand to bring it in line with supply hampered by Covid and the invasion of Ukraine.
  • However, the recent addition of exposure to Portuguese sovereign debt is an example of seeing through the gloom to find opportunities to add income.

Strategy & Positioning – Looking Forward

In last month’s commentary we described the broad picture as being one of (short term) weakness for risk markets as the Fed and other central banks tightened policy.

The higher inflation numbers, continuing hawkish rhetoric of those central banks and ever-more negative data from the US and other economies only served to reinforce our view in June.

Our overwhelming sense is that risk markets will continue to be vulnerable until such time that the Federal Reserve confirms they have raised interest rates sufficiently to control inflation.

We strongly suspect that, when they do make this confirmation, the rebound in risk assets will be significant and rapid. However, its announcement is unlikely to come for a number of months. In the meantime, the Federal Reserve and their global peers (with the notable exception of the Bank of Japan) seem determined to orchestrate a recession; driving down demand to bring it in line with supply hampered by Covid and the invasion of Ukraine.

The Fund’s US Treasury allocation has been (to a great extent) moved further out along the curve (to the 3-10 year range) in anticipation of lower yields as recession really begins to be priced-in. Duration has thus been increased as an active means of profiting from the current environment.

Hedging remains expensive, so we have been cautious of adding hedging in recent months. It is a measure of our pessimism for risk assets that we were prepared to add protection against both high yield and investment grade credit spreads moving wider, even when high yields spreads were approaching 600bps.

However, the recent addition of exposure to Portuguese sovereign debt is an example of seeing through the gloom to find opportunities to add income to the Fund. Portuguese spreads will be supported by the ECB’s anti-fragmentation “tools”, whatever they turn out to be, and also the attractive premiums that the debt offers USD-investors on a currency-hedged basis.

Many of the Fund’s income-producing positions are likely to continue to deliver negative capital returns, even if the income element of the returns they offer has become increasingly positive. But the Fund is positioned to help smooth some of this volatility in the short term, and has the liquidity to pounce on the opportunities that arise.

 

 

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