INSIGHT

BONDS: SEEKING SHELTER WITH INCOME

February 2018

BONDS: SEEKING SHELTER WITH INCOME

By Xiou Ann Lim

Key takeaways

  • Citi projects 6 out of 10 Developed Market (DM) central banks to raise rates in 2018.
  • Emerging market debt has underperformed due to stronger US dollar but remains selectively attractive.
  • Within Investment Grade (IG) bonds, US IG yield levels are at 7-year highs and offer attractive opportunities within Energy, Materials and Financials sectors. In High Yield (HY) bonds, US bank loans continue to offer attractive carry and low price sensitivity.

Citi analysts continue to expect gradual tightening by some central banks.

  • The US Federal Open Market Committee (FOMC) is projected to hike policy rates three times in 2018, the first of which occurred in March, and the second in June.
  • The European Central Bank (ECB), Reserve Bank of Australia (RBA), Reserve Bank of New Zealand (RBNZ) and the Bank of Japan (BoJ) are not expected to raise policy rates until 2019.
  • The Bank of Canada (BoC) hiked monetary policy rates in January, and are likely to follow up with two additional interest rate increases in July and October 2018, once progress has been made on reaching an agreement on the North American Free Trade Agreement (NAFTA).
  • Within Asia, Citi expects rate hikes this year in India, Korea and Taiwan.

Selective regional markets offer value

Despite some pullback in risk appetite, Citi analysts believe Emerging Market Debt (EMD) can still outperform.

For US dollar-denominated bonds, Citi analysts continue to favour Latin America over Asia and Eastern Europe/Africa. In Latin America, Citi is overweight on Brazilian, Colombian and Argentinian bonds.

2018 Global Outlook

In Asia, Chinese real estate and banks can provide value as Chinese real estate yields have increased about 100bps since November 2017. Spreads have been less volatile, an indication that investors are not as concerned about credit risk.

Chinese bank results indicate that margins have expanded while non-performing loans (NPLs) have reduced. Bank capital adequacy ratios rose and have not yet been affected by the ongoing trade dispute as they tend to be more focused on domestic business.

Within Investment Grade bonds, US IG yield levels rose to 7-year highs, creating attractive opportunities within Energy, Materials and Financials. IG bonds have become attractive for investors given supportive fundamentals, wider spreads and benchmark yields at nearly 4 per cent.

Though bond supply should remain robust, the repatriation of off-shore profits may allow some corporations to deleverage. Given the current US economic recovery is in its ninth year, adding high-quality assets with relatively low correlations to equity markets can help clients diversify their portfolios.

In High Yield bonds, concerns over credit fundamentals have driven lower quality issuers to outperform this year. US bank loans continue to offer attractive carry and low price sensitivity. Citi analysts favour B-rated issuers over BB and prefer high yield bank loansHY.

US markets are rapidly evolving post quantitative easing, and Citi analysts believe US high yield should continue to benefit from a supportive global growth outlook, +20 per cent 1Q18 EPS growth, declining net supply and low rates of defaults.

Xiou is a Singapore-based investment specialist for Citi

Important Information:

Disclaimer: This document has been prepared for general information purposes only. Any advice contained in this document has been prepared without taking into account your objectives, financial situation or needs. Before acting on any advice in this document, Citi recommends that you consider if it's appropriate for your particular circumstances. Investors are advised to obtain independent legal, financial, and taxation advice prior to investing.

All opinions and estimates constitute Citigroup Pty Limited AFSL No: 238098 ("CIti") judgement as of the date of this report and are subject to change without notice.