Fixed Income Forward

The end of the US yield-curve steepening trade and attractive income levels make selected long-duration government bonds, high yield and floating-rate credit more compelling.

• In September, the Fed raised its policy rate by 25 basis points to 3.75%-4.00%, the Bank of England held at 3.75%, and the Bank of Japan raised rates by 25 basis points to 1.25%; the France-Germany 10-year spread exceeded 150 basis points, its widest level since 2012.
• The Fed’s unanimous hike, the prospect of less expansionary US fiscal policy after the midterms and increased Treasury buybacks make longer-dated US Treasuries less obviously underweight and weaken the case for further US curve steepening.
• AllianzGI prefers relative-value positions in Europe, expecting 30-year EU bonds to outperform German Bunds because of their AAA rating and declining net supply through 2027; it also expects 30-year UK Gilts to outperform other core government bonds.
• US CCC-or-lower high-yield bonds offered a 12.5% spread pickup over Treasuries, versus about 8.2% a year earlier, while higher-rated credit spreads widened only 25-30 basis points year-to-date.
• Buying and holding 10-year US Treasuries was estimated to deliver an anticipated cumulative return of about 67%, while an AA-rated CLO could offer more than 100 basis points of yield pickup over a similarly rated single corporate bond; European securitised-credit issuance was also at record levels.

Takeaway: Investors should favour selective duration, EU bonds over Bunds, UK Gilts, high-yield income and floating-rate notes or CLOs, while monitoring refinancing risk among weaker issuers, energy-driven stagflation and European fiscal and political uncertainty.