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Citi

Seeking Shelter with Income

Key takeaways

  • Citi projects 6 out of 10 Developed Market (DM) central banks to raise rates in 2018 with US Federal Reserve (Fed): +75bps and Bank of Canada: +75bps. The average DM policy rate is expected to rise to 1% by end-2018, which is the highest rate since 2008 and the largest increase since 2006.
  • Although stronger USD has contributed to recent underperformance in local currency Emerging Market Debt (EMD), Citi analysts remain overweight, though selectivity remains important.
  • Within Investment Grade (IG) bonds, US IG yield levels are at 7-year highs and offer attractive opportunities within Energy, Materials and Financials sectors. In High Yield (HY) bonds, US bank loans continue to offer attractive carry and low price sensitivity.

 

Citi analysts continue to expect gradual tightening by some DM central banks, while the outlook for Emerging Markets central banks is more mixed.

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Selective regional markets offer value

Despite some pullback in risk appetite, Citi analysts believe Emerging Market Debt (EMD) can still outperform.

 

For US dollar-denominated bonds, Citi analysts continue to favor Latam over Asia and Eastern Europe/Africa. In Latam, Citi is overweight on Brazilian, Colombian and Argentinian bonds.

 

Stronger USD has contributed to recent underperformance in local currency bonds. Citi analysts remain overweight on local EM markets, though selectivity remains important.

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In Asia, Chinese real estate and banks can provide value as Chinese real estate yields have increased about 100bps since November 2017. Spreads have been less volatile, an indication that investors are not as concerned about credit risk.

 

Chinese bank results indicate that margins have expanded while non-performing loans (NPLs) have reduced. Bank capital adequacy ratios rose and have not yet been affected by the ongoing trade dispute as they tend to be more focused on domestic business.

 

Within Investment Grade (IG) bonds, US IG yield levels rose to 7-year highs, creating attractive opportunities within Energy, Materials and Financials. IG bonds have become attractive for investors given supportive fundamentals, wider spreads and benchmark yields at nearly 4%.

 

Though bond supply should remain robust, the repatriation of off-shore profits may allow some corporations to delever. Given the current US economic recovery is in its ninth year, adding high-quality assets with relatively low correlations to equity markets can help clients diversify their portfolios.

 

In High Yield (HY) bonds, concerns over credit fundamentals have driven lower quality issuers to outperform this year. US bank loans continue to offer attractive carry and low price sensitivity. Citi analysts favor B-rated issuers over BB and prefer HY bank loans over bonds within Euro HY.

 

US markets are rapidly evolving post-QE, and Citi analysts believe US HY should continue to benefit from a supportive global growth outlook, 20%+ 1Q18 EPS growth, declining net supply and low rates of defaults.

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