Inflation is the watch word for 2017. BNY Mellon Investment Management’s fixed income special report draws on the expertise of fund managers and investment strategists from Newton Investment Management, Insight Investment, Standish Mellon Asset Management, Mellon Capital Management and Alcentra who explore the backdrop for fixed income markets in the opening months of 2017.
While political risk and consequently volatility continues to rise and be one of the biggest drivers of fixed income returns this year, it is rising inflation that is causing investors to pause.
Paul Brain, head of fixed income at Newton Investment Management said, “Inflationary pressures are on the increase in both the US and major European markets such as Germany, driving upward pressure on bond yields but bringing potential benefits to credit markets. One advantage of inflation is that it reduces the value of a company’s underlying debt – potentially reducing the default risk for credit investors”.
April LaRusse, head of fixed income product management at Insight Investment commented, “Inflation may be the cause of some fixed income woes in Europe because it could enhance the disparity across European economies. With European Central Bank (ECB) policies expected to remain loose, even as the recent spate of bond purchases is scaled down, many economies – predominantly those in the periphery – are still trying to establish growth. Meanwhile inflation is starting to creep up in core Europe and particularly in Germany. This could create tensions over the ECB’s expansionary monetary policy with markets potentially questioning if the current level of interest rates is correct for all of Europe.”
He also added that political uncertainty could continue in 2017, particularly in Europe. “Political events in the UK, US and Europe have introduced risks for financial markets, many of which have been absent since before the financial crisis. This year we will start to know more about the UK’s anticipated withdrawal from the European Union as well as the impact of Trump’s assumption of power and initial policies; we can already tell that he won’t be boring. Elsewhere, there are key elections and political events in Italy, France and Germany to pay attention to.”
Turning to investment opportunities, Paul Hatfield, chief investment officer at Alcentra, expects a positive year for the European loans market. “The prospect of future interest rate hikes augurs well for the European loans market which is still very resilient. The European market doesn’t have some of the volatile sectors common in the US market. While Europe won’t benefit directly from any interest rate rises this year we expect the environment will be one of low defaults and we will be fairly defensively positioned all of which means loan prices should hold up fairly well. It looks as though we are in for another year of returns of around 5% in the European loan market.”