Near-term opportunities in global bonds - J.P. Morgan Asset Management
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Near-term opportunities in global bonds

Contributor Bob Michele



Extraordinary central bank liquidity is a short-term tailwind for risk assets
 
By: Bob Michele, Chief Investment Officer and Head of the Global Fixed Income, Currency & Commodities Group, J.P.Morgan Asset Management
 
Every quarter, lead portfolio managers and sector specialists from across J.P. Morgan’s Global Fixed Income, Currency & Commodities platform meet to review the macroeconomic environment and sector-by-sector analyses incorporating fundamentals, quantitative valuations and supply and demand technicals.  We then set forth our expectations for what the market will be pricing in over the next three to six months and, in that context, identify our best investment ideas.
 
Our March meeting took place following several months of extreme risk-off/risk-on market sentiment. Such an environment naturally begs the question: “How near is the next recession and what could trigger it?”
 
Certainly, a growth slowdown is underway. Developed market growth is close to trend, but is being dragged down by slowing, below-trend growth in the emerging markets. However, our proprietary indicators suggest that the near-term probability of recession, though increasing, is only about 30%. Our base-case outlook for the coming three to six months remains Sub-Trend Global Growth and Inflation.
 
Recession, while not imminent, is inevitable. In the years since the global financial crisis, a new set of “unsustainable excesses” has been built. It’s not the U.S. sub-prime market this time, it’s emerging market leverage, particularly in China.  Unwinding those excesses will take decades. In addition, we need to see a further unwind of the investments in shale oil, and the banking sector must continue to shrink its way to profitability, as the reality of regulatory reform hits home. 
 
In the near term, central banks around the globe continue to provide liquidity, and that liquidity is a tailwind for the bond markets.  The ECB’s recent actions were extraordinary.  Even the Fed’s inaction is a form of easing.  And we expect near-term stabilization in China.  In the U.S., we expect at most only a single rate hike this year; we forecast the ten-year Treasury at year end between 1.75% and 2.00%.
 
China remains an obvious threat to our outlook.  And as we near a Brexit vote in June and the U.S. presidential elections in November, we could see increases in fear and market volatility.
 
Investment Implication
 
High quality duration—long government bonds and U.S. agency mortgages—can benefit in the near term from central bank accommodation and in the longer term can provide stability in a risk-off environment.  Likewise, gold can benefit from a variety of scenarios.
 
In the near term, corporate credit continues to provide attractive carry and is poised to benefit from the enormous amounts of liquidity that are being pumped into the markets by the central banks. European high yield, further supported by improving fundamentals and potential upgrades, remains our top idea.  In the U.S., we still think that high yield spreads (ex-energy, metals and mining) more than compensate us for potential defaults, increased volatility and bond market illiquidity.
 
The key with risk assets is to know when to take your chips off the table. As we move through the year, we will be sensitive to signs that downside risks are beginning to outweigh upside opportunities. In some of our more risk-averse strategies, that time may be sooner rather than later.
 
This is going to be an increasingly challenging year to invest in the bond market, demanding that we rely more heavily on our research to put us into the right opportunities and give us the strength of conviction to hold those positions through periodic bouts of volatility. As the post crisis credit cycle continues to evolve, 2016 is likely to be a year of more asymmetric bond price moves and greater differentiation in manager skill. We’re ready!

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