U.S. spread products will be the big winners in the medium to long term.
Our U.S. Investment Strategy service expects the investment backdrop to eventually evolve from one dominated by fears of U.S. recession, a hard landing in China and a European financial meltdown, to one in which U.S. growth remains sluggish but the downside risks are more moderate. The expansion will be held back by the combination of ongoing private sector deleveraging and fiscal consolidation in the developed markets (DM). This combination will require monetary policy in the developed markets to support growth via low rates, potentially for years. Combined with plentiful savings in the emerging markets (China in particular), the deleveraging backdrop in the DM means that the global savings glut will remain a key feature for some time. Several fixed income asset classes stand out as being potential winners in this environment. Investors will favor income over the potential for capital gains. Spreads could narrow to extremely tight levels as the “search for yield” intensifies, similar to what occurred in Japan. The environment will also push investors toward carry trades. Among the U.S. spread product, agency MBS and municipal bonds offer good value. Corporates tend to outperform stocks in a low, but positive growth environment. Corporate credit quality is strong and corporate bonds currently provide a sizable yield advantage relative to competing asset classes, and will benefit in a world where growth is slow enough to keep policy rates low but not slow enough to cause a recession.
This economic backdrop implies minimal interest rate risk and only moderate credit risk.