It is clear that fixed-income investors have recently increased their profit-taking. Many of these have been recent investors who helped global fixed-income markets reach record highs. Schroders believes that further selling could occur as these positions ease.
The widespread sell-off in fixed-income markets was partly due to the US Federal Reserve's decision to cut interest rates by only 0,25 percentage points before the summer, which disappointed many investors. But the fact remains that the markets may have waited too long and needed a correction.
This trend may well continue. Many investors have been unwinding positions they had taken in anticipation of a 0,5 percentage point rate cut and a tighter policy from the Federal Reserve. However, regardless of the degree of change, interest rates appear poised to remain low for some time.
In the US, we believe the increased supply of government bonds will eventually weigh on the markets, and therefore we are maintaining a short-duration position. At the same time, we are focusing on longer-term fixed-income securities to benefit from the higher yields they offer.
One of our preferred fixed-income markets is Europe, where further interest rate cuts by the European Central Bank (ECB) are expected. While economic growth is arguably picking up in the US and Japan, the situation in Europe is not improving, which should be positive for fixed-income investors. We prefer bonds issued by "peripheral" countries such as Austria, Belgium, and Portugal. These have stronger economic fundamentals than "core" countries like France and Germany and are less likely to need to issue more debt to raise funds.
Regarding corporate bond issuances, the market has had a very strong run this year. In fact, the recovery has exceeded our own expectations. In most markets, we have observed record narrowing of credit spreads in recent months, to the point that, in many cases, they have reversed the low yields of the last three years.
Investors initially favored higher-rated issues. However, as value disappeared in this segment of the market, we anticipated a shift towards lower-rated issues and high-yield debt. Therefore, we reduced our exposure to AAA- and AA-rated fixed income in favor of A- and BBB-rated bonds, allowing us to capitalize on this broader market shift. We also benefited from gains in high-yield debt and emerging markets, which have been among the best-performing asset classes this year.
Having come so far in such a short period, we believe it is prudent to take profits and wait to see how the market develops during the quieter summer trading period. However, apart from this, we believe this asset class offers considerable long-term potential. The best returns should be seen in fixed-income issues from companies that are reducing their debt. This is an ongoing process, and we continue to look for the best opportunities to capitalize on this trend.
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