An interview with Mike Rosborough, Senior Portfolio Manager, Investment Director, Global Fixed Income, CalPERS. Part of the Investing in Fixed Income, North America 2017 report.
David Grana, Head of North American Content, Clear Path Analysis: What’s the lay of the land of the fixed income market at the moment?
Mike Rosborough: Around June of 2016, we were at all-time lows in 10-year yields, at around 160 basis points (bps). Today, we are in a reasonable range from 180 to 275 bps. Spreads are tight, although not the tightest that they have been. We see this across emerging market, high yield and corporate spreads. There is clearly a continuing reach for yield.
One of the changes that we’ve seen this year is that the Fed is starting the unwinding of its balance sheet. This could be significant for the fixed income market, but it is too early to tell. Volatility in the bond market, much like with the equity market, has been reasonably compressed this year. On a global scale, we have seen extensions of quantitative easing (QE) in the Eurozone and yield curve control in Japan, which has led to a muted trading range. The greatest significance in the market is in the compression of yield spreads. This means that fixed income investors are still starved for yield globally and this doesn’t look likely to change anytime soon.
David: Last year the big issue around this time of year was around negative yields. Is this something that has now been dampened a bit or are we still seeing a little bit of this being played in this space?
Mike: We passed the worst of that at the end of 2016 and beginning of 2017. We still see negative yields in Europe and Japan, but they have risen somewhat since the summer of 2016. The market seems to have adapted to this phenomenon.
David: What role is geopolitics playing in fixed income?
Mike: Interestingly enough, any anxieties around geopolitics seem to come and go surprisingly quickly. For example, the post-US election reflation trade in 10-year yields came up and faded out. CPI figures have also peaked and come down. As a result, global and domestic yields have come back down after brief periods of peaking.
David: What impact is the Fed’s rate increase and talks about more rate hikes continuing into 2018 doing to the market?
Mike: If you look at past rate hiking cycles in the U.S, during the Greenspan era, what you tended to find was that the whole yield level shifted upwards. This implies that he was getting into the cycle a bit late, and therefore, was behind the curve. Looking at the Bernanke hiking cycle, prior to the Financial Crisis, 10-year yields waxed and waned in a sideways pattern, but ended up where they began. They didn’t begin to fall until after the Financial Crisis hit. This implies that we he was acting on time and was neither ahead of or behind the curve. In the current case, 10-year yields have moved round and you will see the yield-curve flattening, as a purely mechanical function of rate-hiking. This would tell you that the Fed is on track at the moment.
One of the complicating factors is the significant potential changes in Fed membership and governance next year. Janet Yellen’s terms ends in the first quarter as Governor. Stanley Fischer's term ends in the second quarter, and there is speculation as to who will be appointed. There isn’t enough clarity yet to make reasonable speculation as to how that would affect Fed policy and the yield-curve.
I think it’s safe to say that the Fed probably moved more hawkishly on balance sheet unwinding than the market expected. The move does, however, imply a fairly steadily raising rate structure in the U.S.
David: Would the unwind push up yields?
Mike: That is the great unknown. We have never been through a cycle like this before, where the Fed used its balance sheet in this fashion. There isn’t a good historical guide as to what the impact of this is. This is unknown for the Fed as well, which is why they are doing it cautiously by announcing it in advance and communicating it in a way that the market understands what is happening.
David: President Trump has mentioned plans about improving infrastructure in the U.S. What is the correlation between that ambition and the bond market?
Mike: Fiscal expansion is not only the infrastructure policy. There is also the question of potential changes in the tax code, which is the great unknown. There is some speculation, but we just don’t know at this stage what will happen and what impact this will have on bond holders.
David: Are investment behaviors and patterns that were common in the past becoming less prevalent?
Mike: You have significant savings economies which are putting their capital into the world financial system, along with major central banks around with huge balance sheets, which are arguably suppressing yields. These sources of funds which go into fixed income markets didn’t exist when I started managing portfolios. This explains why yields are where they are. As a pension fund, there is nothing more that we would like than to see a big run up in real yield, but with the amount of capital in the market, the spikes and declines of the past are becoming less common.
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