Talking Heads – Capturer les rendements normalisés sur les marchés obligataires

This is an article based on the transcript of the recording of this Talking Heads podcast

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads Podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing opportunities in fixed income markets. I’m Andy Craig, Co-Head of the Investment Insights Centre, and I’m joined by Olivier de Larouziere, Chief Investment Officer for Global Fixed Income. Welcome, Olivier, and thanks for joining me.

Olivier De Larouzière: Thank you.

AC: Over the last year, the US Federal Reserve and the European Central Bank have tightened monetary policy to an extent and at a speed that’s probably unprecedented. As a result, the investment environment for bonds has changed completely. We want to discuss today the opportunities that now exist for investors in fixed income after 15 years of low to no yields. Bond markets corrected abruptly in 2022. What does this mean for investors?

ODL: It’s probably unprecedented in terms of the time elapsed, but not in magnitude. I’ve seen other hikes and especially coming from the Fed or from the Bundesbank historically. And they were always quite brutal. But it was a shock, clearly, to investors. But if you add all this up, it actually comes back to a more normal performance, which usually comes from carry. And that’s the first point that I want to make. The world has changed within fixed income. Yields are back to the positive – and very positive territory in Europe. They are quite high compared to historical levels in the US. This is a normalisation process. What does it change for investors in fixed income? Everything. And I’m not only talking about money markets, I’m talking about longer duration as well. I’m an active manager, so I try to make the best choices, especially in relative terms. I’m seeing this with clients. They now fully understand the change in the global picture on fixed income and that there’s an urgent need to capture these level of yields. At some point, central banks will be easing. There’s been a debate over the last year on that easing cycle, because if central banks overtighten. this should trigger a recession because it is a way to handle the inflationary pressures. And recession means an easing cycle, and an easing cycle means lower yields. So, there is some urgency to capture these level of yields, and there are different ways to do this.

AC: Now, the return of inflation was the trigger for the normalisation of bond yields. How do you see inflation evolving from here?

ODL: It’s been a major surprise for me how the consensus has been giving full credit to the central banks, whereas over the last few years, they have been challenging the central banks in terms of credibility. The quantitative easing policy was actually not generating higher inflation. Now that we have inflation, they’re absolutely confident that hiking rates will take inflation down quickly and that the easing cycles should start quickly. So, this is what central banks have been dealing with over the last year. We’ve had a different view since the start. If central bankers are data-dependent, we need to be as well. We knew this would take longer. It started with commodity prices. The Covid crisis had major consequences for supply chains. Now, it’s not only about commodity prices, it’s about services now as well. The composition of inflation has evolved over the last year. People focus only on headline inflation, which has clearly and mechanically started to come down from something like 10% to 7% more recently. It’s now about services and core goods. And that’s a much stickier inflation. For me, the debate is not on how fast inflation is coming down. It’s on where it’s landing and when. The most important question for central banks is where is it landing? We are not reaching 2% any time soon. It might be the case at the end of 2024, probably later on. So, we have to manage 2023 and 2024 – and this cycle – with much higher inflation numbers. We’re seeing this on the salary side. Europe seems to be more sticky on the inflation front. We’ll know in 6 to 9 months’ time if there is a structural difference between Europe and the US. Mr. Powell [and] Ms. Lagarde will prefer to overtighten and get full proof of how policy has impacted inflation rather than being pushed by financial markets, especially from the equity side, to ease policy anytime soon. This has major consequences for where inflation is landing. If inflation lands at 3% instead of 2%, that’s a more structural problem. Should they tighten forever? I don’t think so. Let’s not forget that they were contemplating and working on a complete shift of policy on long-term inflation. They’ve been doing this over the last year or so. There was a debate on where the inflation target should be. I don’t give [central banks] full credibility in terms of short-term major changes in inflation.

AC: Given this environment, where do you see opportunities today for investors, which are the segments and the sectors within fixed income that you see as particularly attractive?

ODL: A context of low to no yields over the last 10 years meant that a lot of investors were not invested or underweight on fixed income versus their benchmarks or their allocations. We’re giving advice to a number of large institutions who are willing to buy duration. We have a medium to long-term strategy on duration, but, within our funds, we’re more short-term focused. The number one priority is to capture the yields. There are different ways of doing it. Money market rates are back. They offer very low risk. In recent weeks when we had a major stress on some banks and on some parts of the financial sector, we saw absolutely no stress on money markets. At yields of 3%, or 3.5% soon, and 5% and above on euro and US money market rates, it’s a clear opportunity to invest. We’ve seen major inflows in money market funds. A lot of assets are coming from the corporate side. Retail investors need to be educated again, like a lot of investors, on how fixed income behaves. The next opportunity with longer duration is on fixed maturity products – a passive way of capturing yields. If you look at more active asset management portfolios, the obvious choice goes to higher yields and you start to look at corporates and especially in the euro or US area at investment-grade. High-yield is offering a premium, but in the context of a possible recession, which is not our baseline scenario, but with risks of recession, you never want to have a large exposure to higher-yielding corporates. So I would stick with investment-grade. So far, the implied default rates are generous. We are only seeing positive news. So that’s very reassuring. The average yield pickup is something like 1.3% on euro investment-grade versus euro sovereigns, for example. That’s a pretty nice premium compared to historical levels.

AC: Olivier, thank you very much for joining me.

ODL: Thank you.