Andrzej Skiba, Head of BlueBay US Fixed Income, notes that key risk catalysts, such as the budget, trade deals, and labor market stability, have stabilized, with potential for limited Federal Reserve rate cuts later in the year due to benign inflation dynamics.
Watch time: 4 minutes, 42 seconds
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Welcome to the latest edition of The Weekly Fix. My name is Andrzej Skiba.
We’ve now passed the mid-point of the year and we believe it would be a good idea to reflect on the current opportunity set in fixed income.
From a directional perspective, we remain constructive. Each of the three key risk catalysts that we identified a number of months ago has either been resolved or is well clear of the danger zone. The budget has been signed into law, a number of trade deals are soon likely to come to fruition and the labor market is not showing any material signs of weakening. Regarding the Fed, we do see a scope for limited rate cuts later this year, helped by benign underlying inflation dynamics prior to tariff impacts hitting aggregate data. With a good change of average end-state tariffs settling below 15%, this might allow the Fed to cut once or twice in the coming months.
On the other hand, we recognize that market positioning has shifted towards a more bullish stance in multiple segments of our universe. Valuations also screen poorly, with generic spreads retesting multi-year tights and fewer pockets of value left for active investors to exploit. Finally, we note that volatility normally picks up later in the summer as we approach a typical period of heavy issuance in September.
We are responding to these developments in a number of ways:
Across our investment grade portfolios, we’re booking profits on corporate bonds that, in our opinion, have limited upside. We’re focusing attention instead on the remaining pockets of value in sectors like technology, insurance and utilities. We also favor compression theme opportunities in subordinated debt of banks and non-financial corporates, especially those where junior debt trades at a material discount to senior bonds. Away from corporates, we see value in non-agency MBS space and in the BBB-rated segment of the ABS universe. The tighter IG corporate spreads move, the more likely we are to witness investors scouring securitized markets for bonds of issuers that lagged the broader credit spread moves in recent months.
In leveraged finance, with generic spreads in high 200s, we reduced exposure to rich BB-rated and single-B rated bonds and reinvested proceeds in a combination of attractively priced primary market deals and select subordinated debt opportunities in the cross-over space, for example in junior subordinated bonds of US corporates seeking rating agency equity credit to protect their issuer credit ratings. Across the loan space, with many loans trading above par, we’ve sold a number of these addressing our exposure to re-pricing risk. As B2 corporate family rating issuers are now issuing loan deals in 275bp margin context, for those strategies that hold both bonds and loans, we prefer to redeploy some capital from the loan space to the US HY bond universe.
With volatility close to multi-month lows, we’re also selectively adding credit index hedges across a range of portfolios that are allowed to do so. While we always believe that selling bonds is the best way to de-risk portfolios, we see a role for credit hedges in supplementing that effort.
All these actions allow us to moderate the extent of our overweight positioning, while remaining constructive in our outlook for the fixed income universe. If volatility were to spike, we’re well positioned to take advantage of any dislocations.
Thank you for your attention.
Key points
The fixed income market has shifted toward a more bullish stance, with tight valuations, fewer opportunities for active investors, and an expectation of increased volatility later in the summer due to heavy issuance in September.
We have booked profits on corporate bonds with limited upside, focusing on sectors like technology, insurance, and utilities, and exploring opportunities in non-agency MBS (mortgage-backed securities), and BBB-rated ABS (asset-backed securities).
In leveraged finance, the firm has reduced exposure to overvalued bonds and loans, reallocating capital to attractively priced primary market deals, subordinated debt opportunities, and the US high-yield bond universe.
To manage risk and position for potential market dislocations, we have selectively added credit index hedges and reduced exposure to overvalued assets, while maintaining a constructive outlook on the fixed income market.
