2018 Fixed Income Outlook: It's Quiet...Is It Too Quiet?
The macro environment remains supportive for fixed income markets. However, with full valuations and diminished monetary policy support, the margin for error is razor thin as investors identify potential risks. Voya Investment Management's CIO of Fixed Income, Matt Toms, CFA breaks down the major themes of 2018 and discusses the key market trends that are likely to lead to a return of volatility.
Our semi-annual themes provide a framework for our investment decisions. Our holistic view of the economy and global monetary policy helps determine the overall risk budget and portfolio positioning to capitalize on relative value across sectors, while helping inform our bottom-up security selection process.
As we enter 2018, the macro environment remains supportive for the fixed income markets. However, full valuations, diminished monetary policy support and our focus on identifying risks that could drive downside volatility favor “selling into strength” as opposed to “buying on weakness.” Across our platform of fixed income strategies, this will be our primary focus in the first half of 2018.
Investment ThemesGlobal Growth: Global growth will remain solid with all regions contributing positively, despite the ongoing economic transition in China.
U.S. Growth: Growth in the U.S. will remain robust, benefiting from deregulation and, to a lesser extent, corporate tax reform. Consumption growth will continue to be held back by income and wealth inequality.
Inflation: Inflation will remain below the Fed’s target. Upward inflationary pressure from demographic shifts and labor skill shortages will likely increase. However, we believe this pressure will be offset by lingering disinflationary benefits from globalization within the tradable goods sector and the ongoing influence of technology.
Central Banks: The Fed’s cautious pace of interest rate normalization and balance sheet reduction will continue, despite the change in Fed membership. The ECB and BOJ risk further asset price distortion by continuing to pursue expansionary monetary policies, but an aggressive pullback of accommodation risks market disruption.
Corporate Health: Strong nominal growth and corporate tax cuts within the U.S. will provide a continued tailwind to corporate earnings, which will allow companies to absorb modest labor cost increases. Higher earnings will facilitate growth in business investment, but limited consumption growth will continue to favor a return of capital to stakeholders over significantly expanded investment.
Multi-Sector Portfolio Strategy
- Modestly overweight spread assets
- Overweight CLOs, which continue to provide attractive relative value
- Overweight non-agency RMBS and added exposure to credit risk transfer securities as hurricane-related concerns receded
- Security selection remains critical in CMBS as fundamentals have broadly plateaued
- While we remain constructive on corporate credit, current spread levels require a nimble, tactical approach
- Maintain slight overweight to select emerging markets, with a bias towards Latin American sovereigns
- Underweight agency RMBS, as we continue to believe the unwinding of the Fed’s balance sheet skews risk to the downside
- Maintain shorter duration posture across portfolios