Insight Investment

In emerging markets, local currency rates have generally underperformed as higher energy prices and elevated geopolitical risk have driven volatility in local currencies and pushed investors towards the US dollar and hard currency assets. We favour rates exposure in local markets that we believe are relatively robust, such as Poland and Czechia. We are also following Peru, Colombia and Brazil closely for opportunities in their local markets on the back of Presidential elections in the coming months.

Japan continues to chart its own course as elevated inflation, growth at or above trend, and upward pressure on wages and inflation are all suggesting that the Bank of Japan will keep tightening monetary policy. However, Japan is particularly exposed to higher oil prices and, in our opinion, is set to receive a particularly large stagflationary shock. We favour tactically positioning for curve flattening in Japanese rates – but remain cognisant of the potential for dynamics to shift.

Synthetic risk transfers (SRTs), where a bank keeps a loan on its books but pays investors to take on part of the credit risk, are gaining momentum as regulators sharpen their focus on the market’s rapid growth. The ECB is scrutinising financing structures and the Basel Committee has published a detailed assessment of the systemic implications of SRT markets. We generally position SRTs as a targeted, high conviction allocation within our structured credit portfolios, focused on high quality reference pools and experienced bank originators. We’re seeing a virtuous circle: as supply increases, awareness and familiarity with the asset class grows, and more investors enter the market, it supports further issuance.

US Agency Mortgage Backed Securities underperformed significantly in late February and early March, relative to the risk profile of the asset class. Today, we believe increasingly attractive valuations, strong bank demand and a high nominal growth environment should provide support for the asset class in future. After the recent underperformance we closed our underweight position in the asset class – if valuations continue to improve, we may look to move overweight in the sector.

Near-term support has emerged for the USD, as the Iran conflict triggered safe-haven demand. However, rallies are increasingly tactical rather than structural in our view. Global indicators point to firmer growth momentum outside the US, and the structural case for the dollar is deteriorating, thanks to persistent fiscal deficits, an increasingly politicised policy environment, and concerns around the erosion of policy orthodoxy. We expect the USD to weaken gradually over the medium term, particularly versus currencies supported by improving domestic fundamentals and stable policy frameworks.

We believe US investment grade, particularly higher quality A and AA credits, are tactically attractive. Valuations have been pressured by geopolitical risk and by heavy issuance related to M&A activity and large technology companies, but the market is well supported by strong fundamentals and easing supply dynamics. We are positioned to favour higher quality credit, where we believe emerging new issue concessions and resilient earnings make these bonds potentially more attractive than other investment grade markets.

We believe that the conflict in Iran has materially increased the risks to both growth and inflation, with higher energy prices delaying potential Fed cuts while raising the likelihood that weaker growth ultimately drives policy easing further out. We have been positioned for rate cuts later this year and could grow this position, as we believe that the longer the conflict goes on, the more likely that negative impacts on growth will raise the potential for further rate cuts.