Eric Stein, Co-Director of Global Income at Eaton Vance, a leading global asset manager, says that investors could be in a new period of interest rates and inflation that will help and hurt specific bond sectors.
“The intense sell-off in nominal Treasury bonds has been driven both by rising inflation expectations and higher real rates based on the anticipated policies of the Trump administration.
“The post-post crisis years have been defined by declining real rates and seemingly permanent falling inflation expectations. However, both real rates and inflation expectations had been picking up even before the election. Now, after President-elect Donald Trump’s victory, we may be in for a very different bond market.
“More fiscal spending should help boost inflation, especially if wages continue their pre-election march higher. Whether it triggers higher economic growth remains to be seen, and depends on potential tax cuts, regulatory changes, protectionism and targeted infrastructure spending.
“It’s important to remember that rates are still at very low levels from a historical perspective. Yet, the velocity of the move higher could signal the market shifting gears to a reflation mindset.
So what now for investors?
“I believe flexibility is key for investors now, as well as approaches that can profit from higher rates and inflation expectations, and a stronger U.S. dollar, whereas most investment strategies are positioned to only make money from lower interest rates and a weaker dollar.
“Conversely, Treasury bonds could continue to decline due to three negative factors. First, the rising inflation expectations discussed above. Second, we’re going to have more fiscal easing, whether it comes from taxes or spending, or likely some combination of both. That means more issuance of Treasury bonds. Finally, if we get more economic growth, which I think is likely, then that should lower demand for Treasurys.
“For opportunities, I’m watching some of the riskier asset classes, such as high-yield and emerging market bonds. If interest rates rise gradually because the economy is growing faster, these sectors shouldn’t be hurt that much. However, a violent jump in rates could lead to some dislocation in credit markets. High-yield and emerging markets have fallen after the election, and there could be opportunity, whether from an absolute standpoint or relative to U.S. Treasurys.
“Elsewhere, I like TIPS for the reflation trade, but only if investors can hedge the duration risk and focus on inflation breakeven rates. Also attractive now are floating-rate loans, collateralized loan obligations (CLOs) and certain types of mortgage-backed securities.
“While the election of Donald Trump has widened the expected range of both economic and market outcomes, so far the market is indicating a higher probability of better growth rates and a higher interest rate structure. These moves seem to make sense to me.
“Going forward, I think investors should look for strategies that can be opportunistic with long and short positions,” he said.
About Eaton Vance
Eaton Vance (NYSE: EV) is a leading global asset manager whose history dates to 1924. With offices in North America, Europe, Asia and Australia, Eaton Vance and its affiliates managed $334.4 billion in assets as of July 31, 2016, offering institutions and individuals a broad array of investment strategies and wealth management solutions. The Company’s long record of providing exemplary service, timely innovation and attractive returns through a variety of market conditions has made Eaton Vance the investment manager of choice for many of today’s most discerning investors.
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