Most fixed income investors in Europe, the Middle East and Africa (EMEA) are optimistic that the current economic expansion could well last beyond one to two years, according to a study by global investment management firm Invesco.

While APAC is the most convinced the expansion is on track for the next year or two, North American fixed income investors, on the other hand, are less optimistic with over half (52 per cent) believing the expansion will end within a year.
 
Invesco’s second annual Global Fixed Income Study highlights in-depth behaviour of fixed income investors. The study reveals that despite the expectation of a relatively near-term end of the economic cycle, investors are not foreseeing a significant correction in fixed income, but rather expect the rare event of a soft landing with a continued flat yield curve, the study added.

 In this, investors plan to maintain fixed income holdings in the search for yield, taking a more active approach to creating diversified scenarios of return through alternatives, emerging market allocations and investing in China.

The study, conducted face-to-face amongst 145 fixed income specialists and CIOs across EMEA, North America and Asia Pacific representing $14.1 trillion in AUM, also found that investors are increasingly responding to the potential for geopolitical issues to disrupt markets.  Almost half (46 per cent) of investors have adjusted portfolio allocations in response to trade wars.  Wholesale investors are particularly sensitive to such concerns and two thirds (65 per cent) have been influenced by Brexit to alter their European and UK allocations.

Only a third (34 per cent) of institutional investors noted that they are altering European and UK allocations as a result of Brexit. Further, investors’ outlook for the global economy has become more uncertain and divergent, with high global debt cited as the most likely trigger of the next downturn.

The end of the cycle

With the current economic expansion running for nearly ten years –one of the longest on record – some investors are nervous about its further longevity and are alert for triggers which could end it.

Globally, the most common view (49 per cent) amongst fixed income investors is that the end of the cycle is one to two years away i.e. late 2019 through late 2020. However more than a quarter (27 per cent) see an end sooner, within the next six months to one year. When comparing wholesale and institutional investors, wholesale respondents are relatively more pessimistic about the near-term outlook, with 65 per cent expecting the cycle to end within 2 years.

Nick Tolchard, head of Europe, the Middle East & Africa (EMEA) for Invesco Fixed Income commented: “Politics in the US are likely to have contributed to North American fixed income investors’ pessimistic outlook. Elevated rhetoric from the Trump administration regarding trade with China, Europe, Canada, and Mexico, plus actual tariff impositions, have significantly impacted optimism. From a policy and markets perspective, perceptions that the Fed remained determined to remove policy support, and speculation of the potential for the yield curve to invert, would have added to concerns.”

Potential triggers of the next recession

When asked about triggers of the next downturn, respondents were predominantly concerned with high levels of indebtedness, in particular government debt. The focus on debt is unsurprising in the aftermath of record low interest rates for a prolonged period. Investors surveyed believe a rising interest rate environment will have a significant impact on interest costs and default rates.

Other sources of potential disruption were seen as a crisis in emerging markets (the top risk of 15 per cent of investors), followed by a debt bubble in China (13 per cent).

Impact on fixed income

With growing nervousness around the end of the economic cycle, there are some concerns about the potential for material reversals in markets, although concerns are slightly tilted towards equity markets over fixed income. However, investors have a stronger view that credit spreads will widen over the next three years (60 per cent), and that the yield curve will remain flat for a prolonged period of time (45 per cent).

By comparison fixed income investors have fewer concerns about rising inflation (34 per cent) and just one quarter (27 per cent) expect an inverted yield curve in the next few years.

Chinese fixed income exposures on the rise

Chinese fixed income allocations are benefitting as investors look through trade war and geo-political issues in their search for yield and diversification. One third (32 per cent) of fixed income investors globally intend to increase their allocations to China over the next three years, notably in North America (58 per cent). In the US, investors are currently less likely to hold Chinese fixed income products as part of their portfolio but are most likely to be increasing allocations despite rising trade tensions.  This is a significant shift for a nation that tends to invest predominantly in its own (i.e.US) bond markets. For half (51 per cent) of global investors, this is a longer-term strategic decision which will be underpinned by the increased weighting of China in major fixed income indices expected in 2019 and beyond.

Overall, despite a compression in the yield premium that Chinese government bonds have historically offered over US Treasuries, total foreign investment into China’s fixed income market rose rapidly in 2018. China is the world’s third largest bond market, but has long been underweight in (or entirely absent from) the fixed income portfolios of professional investors, despite supportive investment considerations such as relative valuation, yield and expected total returns.

Barriers to investing in Chinese fixed income are seen as coming down prompting investors to take advantage, with the main lingering barriers viewed as being the risk of the asset class, government intervention, and potential restrictions on capital movements.

Nick Tolchard, head of EMEA for Invesco Fixed Income concluded: “While last year’s relatively unified view of the ‘new normalization’ scenario largely came to pass, investors are now increasingly uncertain due to the growing list of potential risks, from both a geopolitical and markets perspective. As a result, fixed income investors are actively re-positioning fixed income portfolios to be better positioned to handle a variety of outcomes.

“Interestingly, fixed income investors across the global are considering a wide variety of portfolio strategies: some are targeting yield; some are seeking the safety of shorter durations or cash in case volatility spikes; and some want the flexibility of floating rate instruments. With there being so many factors consider, it demonstrates how investors need a variety of solutions to deal with the potential risks.” – TradeArabia News Service