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Global credit markets show signs of complacency

Maintaining flexible, long/short exposures across the credit markets, and limiting duration risk is the best way forward investors in today’s challenging fixed income markets, says Charmaine Chin, managing director and head of credit, relative value and event-driven strategies at K2 Advisors, part of Franklin Templeton Investments, in the article below.

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Tom Carnegie

For a generation or more, investors have come to know the fixed income part of their portfolio allocation as a perceived safe haven from riskier assets.

But today’s fixed income markets appear more uncertain than ever, thanks to yields near historical lows, the changing tide of monetary policy globally, and increased policy divergence between the world’s major central banks. In this environment we believe traditional long-only fixed income strategies may be challenged.

We believe in maintaining flexible, long/short exposures across the breadth of the credit market, and limiting duration risk.

Complacent Markets  

The European Central Bank recently announced it would be reducing its monthly purchases of eligible European bonds from €60 million down to €30 million, at least until September 2018.

Unsurprisingly, no interest rate hike was announced, and it is widely expected that the central bank will not raise rates until inflation in the region reaches 2%.

Market reaction after the ECB’s announcement was fairly muted. In fact, the news pushed the yields on the 10 year German bunds lower.1

Elsewhere in the world, the situation is vastly different. In the US, the Federal Reserve has embarked upon a clear rate hike path.

This divergence in central bank policy globally has created clear dispersion in global bond markets, as yields in Europe remain at historical lows. Consider that currently, European junk bonds yield less than US Investment Grade Credit.2

But despite the very different interest rate environments between these two regions, credit spreads across both the US and Europe remain historically tight, as investors on both sides of the pond continue to plough into high yield and investment grade denominated debt.

In this current environment we do not believe that investors are being paid for the risk they are taking with credit spreads where they are.

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