Investment opportunities among rising yields and continuing growth (1/2)
Opportunities linked to central banks
We expect the US Federal Reserve Bank to decide one more rate hike in 2017 and 3 should follow in 2018. We expect a rise towards 3% for the US 10-year yield and to 1% in Germany within the coming year. In the US, we forecast a sharper rise in short-term rates compared to market expectations (see chart). In Europe we expect no rate hike by the ECB until the end of 2018.
Traditional bond investors are at risk as the rise in yields would reduce the value of existing bonds. We offer a number of solutions to benefit from a faster-than-expected rise in interest rates and bond yields in the US. We recommend buying US Floating Rate Notes (FRN) and Credit Linked Notes (CLN) indexed to short-term US rates.
Emerging market bonds (Local Currency)
Most emerging market countries have registered a strong improvement in fundamentals, and key countries such as Brazil and Russia will be able to reduce interest rates as inflation is under control and even falling. Despite fears on protectionism, recent events have actually reassured investors. A currency war is not expected to take place.
Emerging market bonds in local currency offer a high carry of 6.2% (see chart), which leaves room of manoeuvre if yield spreads widen or emerging market currencies depreciate.
The yield spread between EM and US debt has narrowed (see chart) but still remains at a high level vs. pre-2008 financial crisis levels. More downside ahead.