09 Mar 2021

  Fidelity | US | global

Fidelity: Strat snippets: Are higher rates a buying opportunity?

01/03/2021 | Claudio Ferrarese, US, Global 

The reflation narrative is gathering steam and many investors are questioning the extent to which the recent back-up in core government bond yields can continue. Against this backdrop, Fidelity Strategic Bond Fund Co-Manager Claudio Ferrarese gives his outlook for rates and outlines the factors which suggest that this may well present a buying opportunity.


Key points

  • A number of factors such as the vaccine roll-out and potential US fiscal stimulus are driving the reflation narrative across markets.
  • Core government bond yields have risen over recent weeks, but we think higher rates could present a buying opportunity.
  • Elsewhere, within credit, we are mindful that spreads having tightened in a short space of time and we continue to lower the credit risk sensitivity of the Fidelity Strategic Bond Fund.

Recently 10-year US breakeven rates hit their highest levels since 2014 and we have been debating the reflation theme as a team. The roll-out of vaccines, resumption of global trade, talk of additional fiscal stimulus and move higher in oil prices all seem to be contributory factors in this respect. But with headline inflation forecasts in the US for this year and beyond only narrowly clearing two per cent, perhaps 10-year breakeven rates now in excess of two per cent are telling us inflation expectations (in the US at least) are close to fair value?

We will be paying close attention to the rhetoric around further fiscal stimulus not only in the US, but also in Europe. For example, Italy - which has been one of the main sources of volatility for Europe over the past decade - is under new leadership, with wide political support and a soon to be deployed recovery fund.

Another aspect which has given the reflation theme a shot in the arm (no pun intended) is the expectation that excess savings accumulated in the developed world will be spent, at least in part. However, with so much optimism priced in to markets, risks we have to consider include the idea that excess savings remain on the side-lines, not to mention the possibility of a rise in new virus variants, delays in vaccine rollouts and/or renewed lockdowns.

Portfolio panorama

Much ink has been spilled of late on the continued back-up in core government bond yields. In the short run, we think there is potential for animal spirits to take rates a bit higher from here and the curve to steepen further, so have been keeping duration a little lower than usual (between five and six years). That said, we ultimately think higher rates will be hard to resist as a buying opportunity, because the debt stock around the world is much higher than it was pre-Covid-19 - with small moves in risk-free rates having a big impact on the economy and the cost of debt.

In credit terms, the spread compression we’ve seen since Q1 2020 has been remarkable. But one of the other questions we have to ask at this juncture, is how much more juice can be squeezed out of higher ‘beta’ areas? As a case in point (and there are plenty of similar examples), the spread differential between US CCC and single-B rated bonds hasn’t been this low since 2011.

US CCC & lower rated bonds vs. US single-B rated bonds

Source: Fidelity International, Bloomberg, 31 January 2021. References ICE BofA indices: CCC & Lower US High Yield - H0A3 Index, Single-B US High Yield - H0A2 Index.

With credit spreads having tightened a long way in a short space of time, we continue to lower the credit risk sensitivity in the portfolio by trimming high yield and emerging market debt exposures, and intend to keep exposure to lower rated high yield bonds strictly under control.


Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than in other more developed markets. Fidelity’s range of fixed income funds can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the fund investing in them. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.


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