High-yield debt is looking slightly less compelling as value in the asset class has been somewhat eroded, but it remains a relatively attractive source of income. At these valuations, investors are likely to get their coupons but not much in terms of capital gains.
How multi-asset income investors manage interest rate risk in the year ahead will be pivotal, considering the central bank transition underway from easing to tightening.
The fair value range of US 10-year yields could rise toward the 2.75 per cent to 3 per cent range by the end of 2018 as the Fed funds rate is hiked towards 2 per cent; this would imply a modest flattening from current levels, but not the fully flat or inverted curve that some fear.
For bond yields to move more aggressively we would need either a positive growth shock – implausible when the economy is already growing above trend, a hawkish policy surprise – unlikely at least in the first half as the new Fed chair takes the reins, or an inflation surprise – possible, but a limited risk given the structural pressure on wages from globalisation and technology.
As a result, yields should continue to merely grind higher as we enter 2018.
Across the major global central banks, the direction of travel for monetary policy is now largely synchronised, even if the timing of policy changes remains rather divergent. Against this backdrop we expect global yields to move broadly in line with US yields.
Interest rate risk
If interest rates gradually start to move up because the market is becoming comfortable with improving global growth and the dissipation of deflation scares we have had in the last few years, that is a positive for risk assets and bodes well for portfolios with some cyclicality.
It remains important to manage interest rate risk through hedging. Many have been focused on the duration – or interest rate sensitivity – of the fixed income portion of their portfolio.
With interest rates on a gradual but inevitably rising path, having the flexibility to scour the world for yield across different income sources is more crucial than ever.
Talib Sheikh is portfolio manager of JPM Multi-Asset Income Fund
