Fixed income at a turning point: strategies and outlook for 2024

Zoi Fletcher: Hello and a warm welcome to yield curve chronicles: mastering fixed income in volatile markets. This is a series of four short podcasts, which examines fixed income investment strategies against the backdrop of economic uncertainty, potential rate cuts and market volatility. My name is Zoi Fletcher and with me to discuss this topic today, I have Unmesh Bhide and Andres Gomez of LSEG. Our first episode is titled Rate Cut Ripples: The Future of Fixed Income. As central banks consider loosening monetary policy, the future of bond yields and fixed income opportunities remains in focus. So how might these rate cuts influence fixed income portfolios for the rest of the year and into 2025?

Andres Gomez: I'll kick it off. Thank you, Zoi, it seems clear that the interest rate cycle has most likely peaked, and the markets are now anticipating rate cuts. Recent evidence has shown that the US economy is slowing, and the labour markets are cooling off. Inflation is certainly slowing down. A very interesting recent development is that the shape of yield curve is now positively sloped, which this is the first time in two years that this has occurred between the two year the three-year point of the yield curve, a negatively sloped yield curve historically, has been a fairly accurate predictor of economic recessions. It hasn't yet materialized but has a fairly accurate track record. So, for the positive yield curve, albeit it's a slightly positive yield curve, but it's an interesting development that fixed income professionals and other investors will keep a very close eye on for clues on what it may mean for the direction of the economy for the remainder of this year, and certainly going into 2025. A shifting yield curve will certainly draw heavy interest in the fixed income world and trigger investment allocations across the term structure to optimize the shifting interest rate landscape. I think another factor that's playing in fixed income markets is the geopolitical risk, which continues to be a concern around the world, which can flare up at any time. We currently have the Ukraine, Russia, war and the Middle East conflict, if either of these events or other tensions worldwide escalate further, this will undoubtedly be factored into fixed income markets, which will impact trading and portfolio decisions most likely to a fight of safety and certainly increase hedging activities. But Umesh, please share your thoughts in this area.

Unmesh Bhide: Thank you Andrez, I think important part I think, for example, in the US, at the beginning of the year, we were thinking six rate cuts, and now in 2024, and now we expecting, 90 to 100 basis points looking at the future markets, I think the other important aspect would be, you know, what is the rate at which the Fed is going to end the rate cycle? So is it going to be 2.5% or 3% and I think one of the important part that I see here is, for you know, maybe the last 15 years, the rates have been lower, and now it is the first time where you will have rates which will be non-zero or not close to zero, if you want to call that way, which is going to make a difference in terms of, how do you value fixed income? So that, I would say is the first part of it, I think the second part I would also see is, as you mentioned, the geopolitical risk, in a way, I would also think similar to that, is it going to be from a big perspective, like how the debt to GDP ratio continues to rise for most of the nations? And how is that going to play into it from a pure supply and demand perspective? And then how is that going to translate into a high-risk premium? Number one. Number two, is that going to matter from a term structure premium, basically the longer duration assets, like at ten and thirty years, for example. How is that going to change? That is going to be interesting to see as we move forward from 2024 and into 2025 that's, I think, my view here.

Zoi Fletcher: Thank you so much, and I'm afraid that's all we have time for today. But be sure to join us for episode two of this four-part podcast series, where we'll dive into the tools and tactics investors need to weather the storm of unpredictable market shifts this year.

Zoi Fletcher: Welcome to this podcast series titled Yield Curve Chronicles: mastering fixed income in volatile markets. These four short podcasts examine fixed income investment strategies against a backdrop of economic uncertainty, potential rate cuts and market volatility. My name is Zoi Fletcher, and I'm joined by Unmesh Bhide and Andres Gomez of LSEG for our second episode, Volatility Vortex: navigating the 2024 market roller coaster. With unpredictable economic shifts ahead, how can investors prepare for and mitigate risks in 2024? What role does data transparency and accuracy play in managing market volatility and making informed decisions? Unmesh, would you like to start?

Unmesh Bhide: Sure, I think, you know, data plays, I would say, a very critical role in terms of valuing the assets. That, I think, is an important aspect. And I think, I would say, data can be looked at as a different time series perspective the frequency of the data and the impact of the data. So, I would classify that into high frequency data as well as regular data. And I think if you go back to COVID, it was driven much more by high frequency data, because that was a moving indicator in that scenario. So, the data transparency is very important in terms of how do we navigate the markets, and in terms of forward looking indicators, you have to see from data to make a judgment into the accuracy of valuations and how the markets are going to evolve. Andres, what are your thoughts on this? 

Andres Gomez: I think when the markets experience volatility, especially in fixed income markets, it presents both risks and opportunities to investors, and in terms of managing that risk, when the volatility impacts the markets, LSEG needs to be able to provide clients with transparent data, accurate prices and precise analytics and risk measures, just as Umesh just highlighted. In doing so, this helps investors view and access their risk profile on their holdings or on their investments, whether it's the Trading Book, a portfolio, or assets on a balance sheet, where they need to view and analyse their risk and make decisions, like to hedge or adjust the existing hedges, increase their risk profile or increase the level of investments, or simply stay the course of their present strategy. LSEG gives clients a platform to view and manage their risk in a very proactive manner. And in times of volatility, the need to view risk on a more frequent basis will increase for sure. So, allowing clients to not only perform end of day risk, but intraday risk increases quite a bit in these turbulent times when the volatility increases in the marketplace. So, we have a very flexible and versatile platform that allows clients to generate custom, tailored risk measures based on their investment views. Many platforms today have just standard parameters or methodologies to compute the standard measures of risk, but LSEG provides a platform that gives clients a great deal of flexibility and latitude to impose their views on the analytical computation to generate the relevant measures of risk to help them manage their overall profile, either on their investments or in their holdings. 

Zoi Fletcher: I'm afraid we're out of time for today. Thank you both for your insights. Please catch our third episode in the series to discover how to unlock yield in a landscape of changing interest rates and credit spreads.

Zoi Fletcher: Welcome to this podcast series titled Yield Curve Chronicles: mastering fixed income in volatile markets. These four short podcasts examine fixed income investment strategies against a backdrop of economic uncertainty, potential rate cuts and market volatility. My name is Zoi Fletcher, and I'm joined by Umesh Bhide and Andres Gomez of LSEG for our third episode, Chasing Yield: Seizing opportunities in a shifting rate world. And Unmesh, I'll start with you this time. In an evolving environment of interest rate charges and fluctuating credit spreads, where can investors uncover attractive yield opportunities? What data and tools are necessary for identifying and maximizing these investment prospects?

Unmesh Bhide: Thank you, Zoi. So, I think a couple of interesting sectors I would say: one is, I would say CLOs, for example. I think, you know, there has been a kind of evolution in the CLO market. In that sense, for example, you have a AAA CLOs, you know, where they've been attractively priced, and you have a lot of subordination from a credit risk perspective. And in that scenario, I would say, that's one good example in CLOSs, where there are CLOs backed by, you know, broadly syndicated loans, backed by, you know, middle market loans, or, for that matter, you have also private loans. So, I think in a way, you can have various different collateral, but the similar kind of spread product. The other thing that I would say is very interesting is, I think, you know, if you look at it from a pure rates, shape of the curve perspective, you know, the for last two years or so, the curve was inverted, and now it is a, you know, lot more positive sloping in that kind of scenario where, you know, agents, CROs, and all those things start to play up. And like, if you are just looking from a playing the shape of the curve perspective, that will be something to kind of look at it. And I think, you know, as we know, like yield book, is pretty well known in agency analytics, and I think I'll hand over to you. Andres there.

Andres Gomes: Yep, thank you. Umesh, you know, in LSEG analytics and LSEG pricing, we strive to accurately reflect the prices and risk measures that are assumed by the markets. And to point to your question, Zoi, in terms of what tools and data are essential in identifying and capitalizing on these opportunities, we look to accurately model the assumptions and behaviours of certain fixed income characteristics like prepayment behaviour or projected defaults on credit sensitive securities. Then it's up to the investors to make investment or subjective decisions if the market is correct on those assumptions that have been priced into the securities, and if the investors have a different view on what has been assumed in Markets, then they can take an action of either taking on more risk, increasing their level of investment, or hedging their investment. LSEG today provides an array of capabilities and functionality to help clients manage the entire investment cycle. So first, we provide evaluation capabilities to assess relative value, to make trading and investment decisions and evaluate strategies - so, making that investment decision. Second, once an investor has made that decision, we provide portfolio or holdings pricing where you can run daily pricing and analytics and risk management to view your risk profile. So where do you stand today with your investments? How does one compare to their benchmark? Are they positioned to outperform or track the returns of their benchmark? Third is we have forward looking capabilities like scenario analysis, functionality to allow stress testing, regulatory reporting or impose objective views, and have the ability to optimize for its outcome. Then fourth, to tie it all back in, we have backward looking capabilities to assess returns and performance. How did one perform on an absolute basis? How did you perform relative to your benchmark? Were the sources of your return or performance attribution? Did you make the strategic bets to perform and what market factors contributed to the overall return and relative performance. For this entire process in managing the investment cycle, accurate and transparent pricing is critical in helping one manage each component of this cycle. So, thank you, Zoi for the question.

Zoi Fletcher: Thank you, Andres, and Unmesh, thank you both for your insights. We'll leave it there for today, please catch our fourth and final episode in the series entitled, AI Edge: revolutionizing fixed income trading.