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Bonds: Selective Opportunities in Variable Rate Loans

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US sovereign: Citi analysts are underweight short-term US Treasuries, neutral intermediate & long-dated Treasuries, and overweight US TIPS. Large scale fiscal packages have temporarily put a floor in long-dated yields, while short-term rates have diminished appeal given the expectation of higher inflation. Zero interest rate policies (ZIRP) around the world may limit how far long-dated yields can ultimately rise.


High Yield (HY): Following sharp rallies in US HY bonds, Citi analysts prefer higher yielding variable-rate bank loans over bonds. Moving up in the capital structure not only provides lower volatility, but its floating rate component may provide some price protection during periods of rising interest rates. In Europe, HY valuations have richened, though spreads still offer value compared to other parts of the European bond market, particularly amid the beginning stages of an economic recovery. EU policy and ECB purchases may indirectly support prices. Citi analysts prefer Euro bank loans given generally attractive yields.



Investment Grade (IG): In US, Citi analysts favour low BBB credits for yield pick-up, however, interest rate risks have risen. While valuations are rich, continued dovish Fed policy is expected to keep spreads supported during bouts of risk aversion. In Europe, spreads and yields have recovered, supported by improving risk appetite and ECB purchases. Citi analysts see opportunities in lower quality IG and some cyclical sectors.


Emerging Market Debt (EMD): USD sovereign and corporate spreads have tracked Developed Markets (DM) credit spreads tighter as the pandemic effect recedes, though valuations still look relatively attractive when compared to similarly-rated US corporates. Citi analysts prefer Asian and Brazilian HY credit. In local currency bonds, yields are near the lowest on record. Future returns may be predicated on the level at which US rates ultimately stabilize and how that in turn impacts currency exchange rates, where a potential reversal to a stronger dollar may require higher local rates to stabilize the currency.

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