Fixed Income Sector Pulse - March

SPREAD SECTORS

US Investment-Grade Corporates: A rebound in higher-beta commodity-related sectors, combined with a solid technical backdrop, has supported spreads over the past month. T. Rowe Price credit analysts continue to find opportunity in subordinated European bank paper, lower-beta industrials, and select energy-related credits.

European Corporates: Credit spreads tightened further as Athens and European officials negotiated an extension of Greece’s bailout, Ukraine and Russia agreed to a truce, and the market interpreted Fed Chair Yellen’s testimony to Congress as dovish. Corporates continued to anticipate the positive effect of ECB QE which commences in March and provides indirect support to the corporate sector.

EM Local: Local bonds valuations look relatively cheap to developed market sovereigns (though less so versus US Treasuries) but are looking fairly expensive versus dollar-denominated EM sovereigns. Flows have improved modestly but remain low. Inflows are not expected to pick up notably until the strong US dollar bid steadies. Valuations are globally attractive but are also increasingly varied. Growth rates remain subdued in emerging markets. Until they pick up, EM currencies will remain under a cloud.

DEVELOPED SOVEREIGN MARKETS:

US: Stronger inflation expectations, firmer risk markets, better data in Europe, and good US job growth have overwhelmed otherwise lackluster domestic data and led yields higher. Stronger labour market readings and stable inflation expectations have let the Fed win back the narrative and bring the rate hike debate back into focus. The likely depth of any sell-off, however, is restrained by continued pressure on term premiums from soft global economic conditions, the resulting scarcity of global yield, and US economic data (ex labour markets) that has recently downshifted.

Eurozone: The ECB has launched a more aggressive programme of sovereign QE, both in size and scope (i.e., including longer-dated bonds). The growth and inflation outlooks are expected to improve later this year, but monetary policy is likely to remain accommodative for the foreseeable future. Sovereign bond purchases should constrain yields at low levels. Yet valuations are extremely expensive.

Japan: Core inflation continues to undershoot, dragged lower by energy prices. The BoJ has downwardly revised its near-term inflation outlook but is still optimistic of achieving its target within two years. Fourth-quarter growth was a little weaker than expected after a very weak third quarter.

UK: The domestic economy has remained relatively robust, and there are signs of an initial pickup in wages. The market is still pricing in the first rate hike from the BoE in 2016, though this has been brought forward. Event risk is high with the general election in May. The outcome, and resultant impact on fiscal and monetary policy, is highly uncertain.

Canada: Although current growth has been reasonable and inflation close to target, the Bank of Canada (BoC) has shown itself to be more concerned about downside growth risks following the sharp decline in oil prices. The BoC delivered a surprise rate cut in January and looks likely to maintain a dovish bias. Although the market is expensive, an easing bias could keep the market better supported even in the face of rising US yields.

Australia: The Reserve Bank of Australia (RBA) has also opportunistically cut rates, taking advantage of the benign inflation environment and trend of easing monetary policy globally. Growth risks are to the downside given an ongoing decline in commodity prices and terms of trade. A further rate cut is possible, and the RBA is likely to remain accommodative for a considerable period.

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