Central bank policies are generally expected to diverge this year, perhaps dramatically. The US Federal Reserve and Bank of England seem on a gradual path to tightening monetary policy, while the European Central Bank and Bank of Japan remain highly accommodative. Emerging market policymakers are all over the (monetary) map.
Senior portfolio managers from Neuberger Berman offer their view on the impact of policy in the current fixed income environment, across investment grade, EMD, high yield and private debt.
European QE: Devaluing Currency
Jon Jonsson, senior portfolio manager for Global Investment Grade Fixed Income:
“Central bank policy efforts are focusing on what they actually have the ability to influence. In recent years low inflation has largely been a function of currency valuations, which central banks can affect through policy, and commodity prices over which central banks have limited control. Against this backdrop, G4 central banks have generally expanded their balance sheets in recent years.
“Although the Fed and Bank of England may see some decrease in their balance sheets from here, the Bank of Japan will likely remain accommodative and the ECB, with its recent announcement on bond purchases, appears headed in an expansive direction. Growth levels in Europe remain anaemic, but there are some positive signs as the combination of weaker euro, less fiscal austerity, increased credit flows and lower oil prices could boost activity in the euro area. Indeed, the region could eventually see surprises on the upside versus currently very low expectations.”
Emerging Markets: More Easing, More Differences
Rob Drijkoningen, co-head of Emerging Markets Debt:
“In the wake of the 2008 financial crisis, many emerging markets surprised investors with their financial stability relative to heavily indebted developed counterparts. To counteract global weakness, they came to rely heavily on domestic consumption, something that strained the current accounts of some countries. Today, they are more focused on net trade figures—some more successfully than others, with some countries strained by low oil prices and other benefiting.
“However, unlike many developed economies that don’t have the ability to push policy rates any lower, various emerging market countries have plenty of room operate. Those that already have low policy rates may turn to weakening their currencies to support their economies and create inflation. China appears likely to remain in the accommodative camp, with further easing possible should growth move below its target, or if there are signs of destabilisation in the property or banking sectors. The overall picture is one of policy variation, as countries continue to demonstrate attributes that defy their broad characterization as “emerging” markets.”
Policy Support for High Yield
Andrew Wilmont, portfolio manager for European High Yield:
“Central bank policy should influence high yield bond performance but perhaps not in the way some expect. About 80% of the yield in the high yield asset class represents credit—not interest rate—risk. US Federal Reserve rate increases would imply a strengthening economy, supporting issuer fundamentals and likely helping to narrow the credit risk premium, thus offsetting some of the impact of higher rates.
“In Europe, the ECB’s €60bn-a-month bond buying program could prove supportive to high yield as investors seek to move further down the credit spectrum to generate income. Issuers are generally in strong financial shape, having capitalized on low rates to refinance and extend their maturities. Given the extent of ECB easing, even modest economic improvements should benefit such companies.”
Could Fed Guidance Contribute to Disintermediation?
Susan Kasser, head of Private Debt:
“After a slow start, the Fed’s guidance on leveraged lending could be starting to have impact on private credit markets. In 2013, the Fed released initial guidance for investment banks that service the private loans market, to help limit systematic risk. The initial impact of the relatively vague standards was minimal. However, the Fed recently elaborated on its initial statements (covering total leverage on deals, covenants and ability to repay), which, along with heightened market volatility, may have contributed to banks’ holding back on lending in the fourth quarter 2014. More strategically, the guidance as well as increased bank reserve requirements seem likely to encourage the continued disintermediation of private credit from traditional sources. This provides an opportunity for asset managers to step into the breach to assist companies that, given these issues, no longer have access to the public markets.”
Opportunities and Risks
While monetary policy will likely have an impact on economies in 2015, the specifics vary widely according to region and country dynamics. Moreover, the effects are not a “sure thing”; quantitative easing supported US risk assets, but the effectiveness of Europe’s policies is still up in the air. Economic progress to some degree lies outside of central banks’ control—tied to the trajectory of oil prices, the resolution of flash points of conflict (e.g., Russia/Ukraine) and, in some cases, the ability to introduce meaningful structural reforms. In this context, the portfolio managers pursue fundamental opportunities across the spectrum of global fixed income assets.