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Our views 18 September 2023

JP's Journal: Make the most of the autumn sunshine

5 min read

Last week, Royal London Asset Management held its first Fixed Income team presentation in our new offices at 80 Fenchurch Street. It is a great location, and we were able to use our outdoor terrace to catch the early evening autumn sunshine and sunset.

We had a panel of our three fixed income business leaders, along with me, with questions posed to us by Fixed Income Investment Director, Ewan McAlpine. Starting with Craig Inches, the focus was on interest rates and the global economics environment. Craig and his team have done well to navigate the volatility of government markets of recent years and in my view, are a great advert for active management in an asset class falling under the sway of passive strategies. Craig’s message was that we are near the peak in global official rates and that 10-year yields in major markets look good value. With German yields below 2.7% that may not be obvious, compared with 4.3% in the US and UK. But adjusting for hedging costs, that differential disappears. The team remain concerned about debt supply, pointing out that current estimates show around £250bn of UK government debt to be sold annually in the coming years. In my opinion, the approaching slowdown should make fixed rate debt more attractive, albeit that supply may steepen yield curves at longer maturities.

Cash strategies were also discussed, with Craig being asked which of our four liquidity funds he prefers. In answering, he compared the question to that of choosing a favourite child. Nevertheless, he plumped for Short Term Fixed Income as he believes it offers a two-way hedge: flexible enough to benefit from a ‘higher for longer’ scenario but also well placed to gain from a shift to a lower rate environment.

Paola Binns was next up, talking about our outlook for investment grade credit. As Head of Sterling Credit and a manager of a flagship credit fund, Paola outlined our view that investment grade credit spreads were attractive, noting that ‘all-in’ yields (government yield plus the credit spread premium) this year were the highest she had seen in her 17 years at Royal London. Not that she forgot to reference how we believe we differentiate ourselves with our emphasis on secured and highly covenanted debt. There were questions about ESG and Paola explained how climate metrics are constantly evolving, as well as why it was important to work with our climate experts in the Responsible Investment team to keep on top of developments.

Finally, Azhar Hussain addressed global credit, giving insights into the changing nature of high yield, why default rates have confounded the sceptics and how riskier debt has found homes in private credit strategies. A key point he made is that a lot of refinancing has been done when yields were lower, and that consequently, higher rates have had less impact on default rates than widely anticipated. Of course, when bonds and loans come up for renewal there will be higher costs – but we may well be on a downward interest rate trajectory by that point.

Azhar also had some interesting insights into private credit. Some riskier high yield debt has landed here – so taking some stresses away from public markets. But he also noted that private credit has access to different sources of finance and that there was ‘dry powder’ that could be resorted to, to help provide stability in challenging times. Overall, Azhar’s message was upbeat on prospects in his area.

From my perspective, the key messages I wanted to leave with our audience were the coming global slowdown, which I believe will tame present inflation, and that locking into yields at current rates looks sensible. Finally, despite the recent spread tightening, I still retain the view that credit offers sufficient compensation over government debt for us to retain a bias towards credit.

On the market front, the main event last week was a further tightening of euro area monetary policy, with the European Central Bank (ECB) hiking rates by 25 basis points (bps). This was seen as a “dovish hike”, with investors taking heart from the view of the ECB that “interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” Not closing the door to more tightening, but definitely a different tone. But let’s not get too excited as, when asked about cuts, President Lagarde said “this is not even a word that we have pronounced”.

Gilts ended on a weak note, offsetting the rally sparked by the ECB’s dovish words. Nevertheless, 10-year yields finished lower at 4.35%, although ultra-long dated yields ended marginally higher over the week. US 10-year rates moved higher, finishing at 4.3%, whilst 30-year yields closed at 4.4%, mirroring the 7bps increase seen at 10 years. As in the UK, the rally seen in euro area bonds fizzled out on Friday, with the net result that German 10-year yields ended the week higher, only 0.1% below the 2.75% high for 2023. Investment grade and high yield credit markets were little changed in spread terms.

Let’s make the most of the sunshine as I forecast colder times ahead – and that applies to the weather as well.


This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.