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Citi

Bonds: US Variable-Rate Bank Loans among Preferred Segments

  • Broadly speaking, valuations have not improved for Global Fixed Income and Citi’s Global Investment Committee (GIC) remains largely underweight to global fixed income even though they have reduced the underweight allocation. Despite that, the GIC are neutral long-duration US Treasuries (USTs) as a risk hedge, and overweight US Treasury Inflation Protected Securities (TIPS) to earn compensation for potentially rising inflation. Zero interest rate policies around the world may limit how far long-dated yields can ultimately rise, but Citi analysts expect a range of 1.5% - 2.0% in 2021 for the 10y UST yield, trending towards 2.5% in future expansion years. Comparatively, European and Japanese government bonds have nominal yields near zero and these form the GIC’s largest fixed income underweights.

 

  • In the high yield (HY) segment, the GIC has further added to their overweight through US variable rate loans. Citi analysts see them as a fixed income standout on risk/reward, with yields averaging 4.3% but one-third less volatility than high yield bonds and two-thirds less volatility than equities. Credit stress has receded given the massive fiscal stimulus and re-opening of the economy and falling default rates could help to support the asset class. Its floating-rate component of the yield is also important as the economy recovers and signs of inflation start to emerge. A scenario in which short-term rates begin to rise from historically low levels are likely to beneficial for holders of these securities.

 

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  • The GIC also retained its overweight to Emerging Market Debt (EMD). USD sovereign and corporate spreads have tracked developed market credit spreads tighter as the pandemic effect recedes. However, relative to similarly-rated US corporates, valuations still appear attractive. Citi analysts prefer Asian and Brazilian HY credit.  In local EMD, yields are near the lowest on record. Future returns may depend on the level at which US rates stabilize and how that in turn impacts currency exchange rates, where a potential reversal to a stronger USD may require higher local rates to stabilize the currency.

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