EPIC Markets Fixed Income View

We continue to await the opportunity to buy into market weakness as we look for the Fed to react aggressively to inflationary pressures, which we believe will lead to a policy error at the cost of economic growth. Our view is that just as the extreme level of inflation starts to fall back towards the Fed’s 2% target the central bank will be in full tightening mode, economic data will start to falter, wages will stabilise and prices within the economy will move lower.  

In this regard we maintain our barbell strategy where we have long dated, high quality credit while also having a large position in cash substitutes. Broadly, we have around 30% of the funds in credit and cash maturing in less than 4 years, and over 50% invested in credits maturing in longer than 12 years, with 30% maturing in +17 years.  

Longer dated bonds can perform very well as the Fed moves ahead of the curve, as can be seen with the inversion in the yield curve from 20-year UST to 30-year UST. This reflects the market's near-term risk of inflation remaining high while the longer-term expectation is for falling inflation.  

The Fed’s aggressive activity of tapering and raising the funds rate, maybe 3 times over the next 6 months, while reducing their balance sheet through non-reinvestment, will curtail economic activity just as we emerge from the somewhat patchy growth seen during the pandemic, possibly even with observers moving up the chances of a recession early next year.  

We feel the buying opportunity is not that far away, possibly, within the next month or so as we get closer to the Fed lift-off. As mentioned, we hold highly rated assets with the portfolios carrying a weighted average rating factor (WARF) of A1/A2, we expect this to continue unless we see a dramatic widening in BBB spreads, as currently there are few lesser credits which offer value. However, a sell-off in the stock market may cause spread widening in the lesser rated names, again offering us the opportunity to add to the portfolio’s positions.  

Also, it is the first Friday of February, which means its Non-Farm Payrolls. The estimates are for 125k jobs added an unemployment rate of 3.9% and participation rate of 61.9%. Average hourly earnings are eyed at 0.5% mom and 5.2% yoy.   
 
Fixed Income Team