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Interest rates

Now that the Federal Reserve has moved into tightening mode, it’s worth asking when the US deficits and overall debt could become a source of worry. As long as interest rates stay reasonably low without driving persistently high inflation, I believe deficits and the debt won’t matter too much to the economy or markets. The debt won’t be painful to finance and can continue to grow — within reason. In fact, if economic growth is higher than the interest rate on government borrowing, it’s possible for debt to GDP to shrink even amid sizeable deficits.

The risk of regime change

If rates move up dramatically, however, the cost of financing the debt will go up and pressure the deficit, as higher debt servicing costs will either crowd out other government spending (unlikely) or increase the deficit further (compounding the problem).

For this reason, I think the Fed will be cautious in its tightening approach, with an eye on the “terminal value” of rate hikes. It can steer short rates directly, but shorter-term Treasury bills constitute a little less than 20% of the debt. To influence longer-term rates, it can…

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Adam Berger
Adam Berger
CFA
Multi-Asset Strategist
Boston
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2021 was, by all accounts, a good year for convertible bonds (“convertibles”). Despite bouts of volatility along the way, both US and global convertibles posted positive total returns last year, comfortably outpacing many other fixed income market sectors — including sovereign government bonds, as well as high-yield and investment-grade corporates.

Looking forward, we believe convertibles may continue to prove resilient, potentially benefiting from their distinctive structure amid the anticipated inflationary and rising-rate environment of 2022. Here are those three predictions for the year ahead.

Prediction 1: Convertibles to outperform both investment-grade and high-yield bonds

Since 1998, convertibles have outperformed both the Bloomberg US Aggregate Bond Index and the Bloomberg US Corporate Index in every period when interest rates rose by…

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Dunkelberger, Raina
Raina Dunkelberger
CFA
Investment Specialist
Boston
Barry, Michael
Michael Barry
Fixed Income Portfolio Manager
Boston

Barring unforeseen macro or market developments, we believe the bank loan asset class looks poised to deliver positive total returns in 2022. Here’s why:

Inflationary pressures have raised the risk of tighter monetary policy

As we move into 2022, inflation risks remain paramount from an investment standpoint. We expect many investors to grapple with the potentially adverse effects on their portfolios, particularly as ongoing repercussions from the COVID-19 pandemic continue to exacerbate labor shortages and supply chain disruptions worldwide. Broadly speaking, we think mounting inflationary pressures have ratcheted up the risk of tighter monetary policy on the part of the US Federal Reserve (Fed) and…

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Jeffrey Heuer
Jeff Heuer
CFA
Fixed Income Portfolio Manager
Boston
Dave Marshak headshot
David Marshak
Fixed Income Portfolio Manager
Boston
Nick Leichtman
Nick Leichtman
CFA
Investment Specialist
Boston

As discussed in my recently published 2022 Fixed Income Outlook, co-authored by my colleague Jitu Naidu, we believe inflation and interest-rate risks look poised to supplant the global COVID-19 pandemic as the new “bogeymen” facing investors in 2022. The dual specter of persistently higher inflation and steadily rising rates has many allocators particularly worried about potential implications for their fixed income exposures. Accordingly, many are now seeking defensive portfolio strategies — so-called “hedges” — for the new year.

Possible inflation scenarios

Market pricing for longer-term US inflation was recently in the mid-2% range, based on the latest “breakeven” inflation rates. There are still ongoing debates as to likely inflation outcomes going forward, but most of the informed forecasts appear to…

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Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

With a sustained rise in interest rates in the coming months a distinct possibility as of this writing, we thought now would be an opportune time to take a close look at some potential impacts of higher rates on clients’ fixed income portfolios. To do so, we compared the hypothetical five-year performance of the Bloomberg US Aggregate Bond Index under three different illustrative scenarios that could play out going forward: 1) rates remain unchanged; 2) rates rise abruptly; and 3) rates rise gradually (i.e., over three years).

Key takeaways for fixed income investors

A few of our main takeaways from this analysis were as follows:

  • While abrupt rises in rates might lead to short-term drawdowns in fixed income portfolios, they can at times be desirable for longer-term investors, given opportunities to…
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Amar Reganti
Amar Reganti
Investment Director
Boston
Jonathan Tan
Jonathan Tan
CFA
Investment Specialist
Singapore

It’s been a volatile ride for the US fixed income market through the first half of 2021. After interest rates seemed to be more or less “renormalizing” in their climb back to pre-pandemic levels, the US Treasury market rallied: In the span of three months, the yield on the 10-year note dropped from 1.74% on March 31 to 1.45% on June 30.

To many market participants, this downward move may seem counterintuitive. US economic activity has continued to pick up with the widespread, successful rollouts of the COVID-19 vaccinations. Accommodative monetary policy along with generous fiscal policy should be a strong tailwind to economic growth into the second half of 2021 and beyond. And inflationary pressures have clearly increased over the past few months.

In theory, all of this should translate into higher interest rates, but that hasn’t…

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Amar Reganti
Amar Reganti
Investment Director
Boston

In my February 2021 blog post, Anchors aweigh at the short end?, co-authored with my colleague Caroline Casavant, we shared our outlook for short-end interest rates and short-duration credit assets, along with an idea on how to diversify liquidity sources through exposure to short-hedged non-USD government bills.

By way of follow-up here, here’s an actionable implementation strategy for investors to consider: “Tier” cash-management buckets and select investment components for each tier to enhance yield on excess cash balances.

An actionable strategy

Given today’s historically low interest rates, many clients wish to boost the yield on their operating cash, but without compromising the important role of cash as a source of portfolio liquidity. We believe the answer may lie in “tiering” one’s cash investments to ensure…

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Andrew Bayerl
Andrew Bayerl
CFA, CAIA
Investment Director
Boston

With front-end US interest rates flirting with the zero mark recently, the question of how to manage cash investments in a world of ultralow or even negative yields has been top of mind these days. So I’d like to share my latest thoughts, from an investment treasurer’s standpoint, on how investors with cash positions might navigate this challenging landscape.

Nothing special about ultralow or negative rates

The decline in yields over the past year or so has had a meaningful impact on the search for incremental alpha, particularly in the cash and short-duration space. Many institutional clients need or want to put languishing cash balances to work in an effort to…

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Jeff Saul
Jeff Saul
Manager, Investment Treasury & Investment Implementation, EMEA
London

Investors can breathe a collective sigh of relief — for now anyway. The Federal Open Market Committee’s (FOMC’s) March statement and press conference suggested that the FOMC is likely to look through any inflation pickups this year and wait until the labor market has recovered to assess whether inflation can sustainably stay around 2%.

The FOMC projects significant improvement in the unemployment rate and a modest overshoot of its 2% average inflation target in 2021. But even against expectations for higher growth and inflation this year, the median FOMC member’s forecast still anticipated the…

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Jeremy Forster
Jeremy Forster
Fixed Income Portfolio Manager
Boston

Interest rates have been rising since August 2020, with the yield on the 10-year US Treasury bond having drifted 100 basis points (bps) higher over the past six months or so. But recent rate action has really caught the market’s attention, particularly the 10-year yield’s swift 30 bps increase and the spillover into global equity markets.

Is the latest bout of “rate repricing” due to higher inflation expectations? Stronger economic growth? Treasury supply issues? “Fed fighting”? Let’s try to make sense of it all.

Yields have risen for the right reasons — Rates have been adjusting to prospects for better growth and higher inflation for months now, reflecting an improving pandemic outlook and ample policy support. Rising inflation expectations are baked into wider spreads between Treasury yields and real (inflation-adjusted) yields, using 10-year Treasury Inflation-Protected Securities (TIPs) as a proxy. Orderly rate moves have been absorbed by…

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Nanette Abuhoff Jacobson
Nanette Abuhoff Jacobson
Global Investment and Multi-Asset Strategist
Boston

The number one question most cash investors are asking themselves (and us) these days is: How long are we going to be stuck in this “zero-bound” range for short-duration interest rates? Here are our latest thoughts on that and related matters.

  • All eyes on short-term rates: We expect the short end of the US yield curve to remain anchored lower for the foreseeable future, but we believe the risks are skewed to the upside in the second half of 2021 due to COVID-vaccine progress, a gradually reopening (and recovering) economy, and the massive amounts of fiscal and monetary stimulus already flowing through the system. Those factors may result in mounting inflationary pressures in the months ahead, which in turn could lead the market to begin pricing in higher short-term rates (i.e., a potential Fed rate hike) sooner than currently anticipated.
  • No Fed? No problem: As of year-end 2020, the permanent closure of some of the US Federal Reserve (Fed) lending facilities that were created by the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act —particularly the credit facilities (PMCCF and SMCCF) and TALF — removed…

 

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Caroline Casavant
Caroline Casavant
Investment Analyst
Boston
Andrew Bayerl
Andrew Bayerl
CFA, CAIA
Investment Director
Boston
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