Russell Investments releases results from Q2 fixed income survey
Fixed income managers expect interest rates to peak at 3%, a shift higher in expectations, according to a new Russell Investments Q2 survey.
In a significant opinion change, money managers now believe economic growth will be stronger than indicated in previous polls. However, they are also pricing inflation to come in around 2.16%, which means GDP growth of only about 80 basis points; still reflecting a recession.
The survey featured responses from 62 leading bond and currency managers across the space and focused on eight specialty areas: global interest rates, global investment grade and leveraged credit, emerging market local and hard currency debt, municipal bonds, securitized bonds and currencies.
It concluded that managers have made room for market volatility, with rate hikes in the US and globally meaning likely market dislocation, particularly around valuations and spreads on an absolute and relative basis. The consensus was a lot less bullish than last quarter, with Russell Investments suggesting that respondents have possibly underestimated the volatility potential in certain places.
Adam Smears, head of fixed income research at Russell Investments, said: “One of the questions we asked was where do you expect the Fed will finish its hiking cycle? Where will its terminal rate be? They used to think low twos and then when you asked them about inflation, their inflation level would be around 2% or just under 2%. You’re actually implying a big recession on the horizon and you’re looking at real GDP numbers of 30 basis points.
“What we’ve seen in this survey is that has changed a lot. They have raised their expectations on average for the terminal rate quite substantially – it’s expected to peak at just under 3%. That’s a meaningful move up.”
Smears added that there is probably a ratchet point at which rising rates start to be more negative to the economy but that it’s hard to tell where that is. He said: “That is one thing to keep an eye on as rates go higher; how high this economy ceiling will go before you get economic damage?”
The survey also revealed that credit managers, although still positive, were less so, with cracks starting to appear because of higher rates and the prospect of trade conflicts. Whereas rate managers were negative on the economy and credit managers bullish, the two are becoming more aligned. Credit managers who were expecting improvements in fundamentals went down from 89% to 55%.
Smears said the other takeaway was that managers were a bit early on emerging markets, with the 45% who were strongly positive on EM down to 20% this quarter.
He said: “We’ve seen the Argentinian peso under pressure, we’ve seen Turkish lira under significant pressure, while the South African rand has fallen out of bed … so a number of EM currencies are definitely getting pressured by this tighter monetary environment.
“The management community went a little bit early and are perhaps getting a little bit shaken on this. EM local currencies will be one area that really gets hit by rising rates so one would think that opportunities are going to arise in that space as investors get shaken out of the trade.”