Risks and Rewards as Yields Fall

Text transcript

Andrew Kronschnabel, head of investment grade credit at Metlife Investment Management and portfolio manager for the Renaissance U.S. Corporate Bond Fund.

High on investors focus this year is the U.S. Federal Reserve and where the Treasury market is heading. While my expertise is corporate debt, I’ve collected input from my colleagues that focus more closely on the sovereign debt markets. Our top of the house call from our economist, Drew Madis, is for 50 basis points of Fed rate cuts in 2019 and our forecast for 10-year Treasurys is to end 2019 at 2.15% and end 2020 at 2.45%. If rates in fact do remain at these relatively low levels, or go lower from here, then emerging markets sovereign dollar debt and local debt should continue to attract inflows as nominal and real rates offer more attractive yields.

The flow picture to non-U.S. sovereigns is attractive at lower yields. Additionally, the technical outlook remains supportive as net supply has been very low. We like to gain exposure via GCC—or Gulf Cooperation Council—countries and add idiosyncratic risk in places like Ukraine or local currency risk in countries like Brazil, where IMF backing or domestic reform agendas control shorter-term asset price performance.

The caveat to these recommendations is growth. If global growth continues to deteriorate past the point of a typical mid-cycle slowdown, then we anticipate risk assets, especially emerging markets and non-U.S. sovereigns, to perform poorly. In order to evaluate where global growth may be heading, we’re watching for bottoming signs in Europe, which we have yet to see as the data continues to deteriorate and the impact of the tremendous amount of fiscal and monetary stimulus that China has put into their market to take hold—which is also yet to take hold. Certainly global trade will impact the growth picture, and the outlook on that front is currently unclear as well.