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Fixed Income

Escaping the Negative Yield Trap

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As the global supply of negative-yielding bonds surpasses $13tn, Citi analysts are underweight negative-yield bonds in local markets, instead preferring high quality USD bonds.

 

  • Historically, income from bonds has been vital to core portfolios and reinvesting bond income has provided a major source of long-term total returns. A regular flow of bond income has also served to preserve capital by stabilizing core portfolio returns over time, and particularly during periods of market stress. However, global fixed income markets are suffering from an intense shortage of yield. In many markets, yields have actually turned negative. After considering inflation, real bond yields have now turned negative in every single developed country. Moreover, there seems little immediate prospect of any lasting respite. Central bank bond purchases are seen persisting throughout 2020 – this reduces the net supply of high quality bonds, keeps rates low and provokes a reach for yield.

 

  • Credit markets begin 2020 much differently than last year with a more expensive starting point is expected to limit fixed income performance this year. Global fixed income returns are expected between 1-2%, favoring credit over rates and US/Asia over Europe. Citi analysts favor extending duration beyond cash in high quality bonds. The preferred market for duration extension is US investment grade (IG) corporate bonds (5-10 year maturities), where yield curves are relatively less flat. While valuations are rich, pockets of value may be found in cyclical sectors that may provide better insulation from any rise in rates.

 

  • Asian yield pick-up potential. US dollar denominated bonds issued by Asian firms and government entitles offer a good potential source of carry for fixed income investors. For IG, the average yields are about 3%, which is 10-40bps higher than US corporate yields with similar rating and duration. Other factors supportive of Asian IG and high yield bonds are a tightening of supply in 2020 and a continuation of monetary easing in various countries in Asia ex-Japan, thereby boosting their relative appeal.

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