In this week’s IDB we take a look at key fixed income investment themes for 2017 and consider how firmer economic conditions are shaping bond asset allocation.
- The second half of 2016 saw US growth and inflation indicators steadily improve, and following Donald Trump’s election victory, reflationary hopes were reinforced. This was followed in Q4 by a notable jump higher in Fed rate expectations, and consequently a shift higher in US Treasury yields. We should expect Treasury yields to gradually edge up throughout this year, therefore limiting government bond exposure and making duration risk crucial. The focus of asset allocation should therefore be on sectors with lower interest rate sensitivity.
- Financial bonds will continue to be a key fixed income theme for 2017. The regulatory environment will maintain the drive towards cleaner and stronger balance sheets, while the shift in politics should help increase bank profitability. Valuations look attractive, especially when compared to pre-financial crisis spread levels.
- Improving economic momentum, low default rates and refinancing risk are favourable for high yield bonds. Valuations are mixed, but there is room for spread tightening if a selective approach is taken.
- Better economic conditions, together with less external vulnerability, will support EM bonds, but again a selective approach is necessary.
- Finally, investment grade bonds will benefit from a stronger economy, but exposure should focus on cyclically sensitive sectors.