Russell Investments Survey: Inflation Expectations Surge Among Fixed Income Managers
Russell Investments' latest quarterly survey of fixed income managers found about 70% expect inflation for the next 12 months to exceed 2%, surging from 38% who expressed that view in the Q1 survey. The 72 bond and currency managers who responded to the Q2 2021 survey also expressed less confidence that the U.S. Federal Reserve (Fed) will deliver its target inflation rate. About 50% of respondents expect the Fed to deliver its inflation promise, declining about 10 percentage points from the previous survey.
"Fixed income managers expect higher inflation to continue a little longer as the transition from lockdowns to full economic recovery accelerates," said Adam Smears, Senior Director, Investment Research - Fixed Income at Russell Investments. "With higher inflation on their radar and the prospect for interest rate hikes moving forward, we expect managers will be digging deeper into asset classes in their hunt for yield."
The survey found 31% of fixed income managers expect the Fed to start tapering its asset purchase program as soon as in Q4 2021, though, the consensus pins the timing on Q1 2022. Respondents also believe interest rates will remain lower for longer. About 80% expect the next Fed hike not to occur before 2023, increasing from 36% in the Q1 2021 survey. After lift-off, 80% of managers expect between two to four interest rate hikes per year.
The survey also revealed less consensus around movement of the U.S. yield curve, with 43% of managers expecting a bear steepening of the yield curve in the next 12 months (versus 71% in the Q1 2021 survey.) In addition, 86% expect the 10-year U.S. Treasury yield to trade between 2.0% and 3.0% in the next 12 months, including 45% who pin it between 2.5% and 2.75%.
The Q2 survey also assessed sentiment among fixed income managers for investment-grade (IG) credit, leveraged credit, emerging markets, currencies and securitized sectors.
- Investment-grade credit: Almost 30% of respondents expect a moderate widening in spreads in the next 12 months (up from just 5% in Q1 2021.), versus 60% predict range-bound spreads. Overall, respondents expect spreads to widen by 5 basis points, revealing a change in sentiment from the Q1 2021 survey when managers expected a spread compression of -6 basis points. Meanwhile, 70% of managers remain confident on declining leverage of IG companies whilst almost 30% of manager expect leverage to remain at least stable over the next year. Regarding areas of potential material mispricing, managers pointed to the energy and utilities sectors, given increasing investor focus on environmental, social and governance (ESG).
- Leveraged credit: 83% of managers expect range-bound spreads over the next 12 months versus 50% in the Q1 survey, while only 9% still expect a moderate tightening. In addition, 70% expect to see a material improvement in corporate fundamentals, surging from 5% more than in the Q1 survey. Respondents see U.S. leveraged loans as offering the most compelling market opportunities, followed by CLO Mezzanine. Regarding the most concerning potential risks for the global high yield market in the next 12 months, managers selected inflation and rising interest rates. No manager expressed concerns about inflation in our Q1 21 survey. In addition, almost 80% of managers expect defaults to be between 0-3% in the next 12 months, compared to 50% in the Q1 survey who saw defaults in the 3-5% range.
- Emerging markets (EM): Survey respondents remain very constructive on EM currencies, with almost 86% expecting a positive performance of developing currencies in the next 12 months. Roughly 17% of managers expect EM FX to post strong positive returns over the period, dropping from 40% in the Q1 survey, while 11% expect FX to be a detractor. Looking at EM FX opportunities, managers expect the Brazilian real and the Russian ruble to outperform in the next 12 months, while 35% expect Turkish lira to be the worst-performing EM currency, in stark contrast to the previous survey where the Turkish lira was the top overweight trade. Overall, 63% of managers expect positive FX returns in the next 12 months, including 10% who see rates as offering the most positive return potential.
Regarding the hard currency emerging market debt (HC EMD) space, managers are less bullish. Only 33% expect spreads in the benchmark to tighten in the next 12 months, dropping from 74% in the Q1 survey. They expect a weighted-average return at 3.9% over the next 12 months. Regarding country preferences, managers selected Ukraine and Egypt as offering the highest expected return over the next 12 months. China and the Philippines remain as the top two underweight countries. In addition, managers picked Fed policy followed by changes in the level of U.S. Treasuries as the top two most significant risk factors for hard currency EMD performance in the next 12 months.
- Securitized sectors: Managers expressed more conservative views in the securitized segment. Only 19% plan to add risks in their return-oriented securitized portfolios in the next 12 months, dropping from 50% in the Q1 survey, while 67% expect to maintain current risk levels. When asked about taking a meaningful beta position, 22% expressed already having a long basis in their portfolios, down from 64% in the Q1 survey, while 50% expect to add short positions. The survey also found 48% of managers expect non-agency spreads to moderately tighten in the next 12 months, declining from 57% in the Q1 survey, while 29% expect spreads to be range bound. Regarding long/short positions on CMBX.6.BBB-, 47% of managers responded they would take a short position, while 32% responded that they would buy protection. As for the CLO market, managers expressed more balanced views with 57% mentioning broad risk-off market sentiment as the main risk, followed by underlying loan collateral credit deterioration.
About Russell Investments
Russell Investments is a leading global investment solutions firm with $326.9 billion in assets under management (as of 3/31/2021) and $2.8 trillion in assets under advisement (as of 12/31/2020) for clients in 32 countries, The firm provides a wide range of investment capabilities to institutional investors, financial intermediaries, and individual investors around the world. Building on an 85-year legacy of continuous innovation to deliver exceptional value to clients, Russell Investments works every day to improve people's financial security. Headquartered in Seattle, Washington, Russell Investments has offices in 19 cities around the world, including in New York, London, Tokyo, and Shanghai. For more information, please visit www.russellinvestments.com.
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