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Global Fixed Income Bulletin
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März 23, 2022

Navigating through the Fog of War

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März 23, 2022

Navigating through the Fog of War


Global Fixed Income Bulletin

Navigating through the Fog of War

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März 23, 2022

 
 

February was a challenging month for financial markets, with most assets reporting negative returns. Most of the month was dominated by stronger-than-expected inflation causing central banks to turn more hawkish, causing fixed income assets, government bonds in particular, to perform poorly. However, the large-scale Russian invasion of Ukraine, which most investors did not anticipate, caused risky assets—equities, corporate credit, emerging market debt—to sell off. European assets did worse than U.S., which makes sense given Western Europe’s economic linkages to central and Eastern Europe. The rise in energy prices—both oil and natural gas—is of particular concern for the European economic outlook given it is effectively a tax on consumers. European bank debt and equity also suffered due to concerns about Eastern European exposure and the impact Western sanctions will have on the financial sector. While government bonds staged a dramatic rally in response to the invasion, they still delivered negative returns for the month. The U.S. dollar and Swiss franc rose, given their “safe-haven” status, as did commodity currencies like the Australian and New Zealand dollar. The Russian ruble depreciated around 30% due to the impact of sanctions; other Russian assets also depreciated in value significantly, the extent to which is difficult to know for sure given illiquidity. Reduced liquidity in financial markets is exacerbating downward price pressures making it difficult to disentangle changes in fundamentals from temporary dislocations.

 
 
 
DISPLAY 1: Asset Performance Year-to-Date
 

Note: USD-based performance. Source: Bloomberg. Data as of February 28, 2022. The indexes are provided for illustrative purposes only and are not meant to depict the performance of a specific investment. Past performance is no guarantee of future results. See below for index definitions.

 
 
DISPLAY 2: Currency Monthly Changes Versus U.S. Dollar
 

Note: Positive change means appreciation of the currency against the USD. Source: Bloomberg. Data as of February 28, 2022.

 
 
DISPLAY 3: Major Monthly Changes in 10-Year Yields and Spreads
 

Source: Bloomberg, JPMorgan. Data as of February 28, 2022.

 
 

Fixed Income Outlook

Financial markets have gone from worrying about COVID-19 to worrying about the Russian invasion of Ukraine. The main impact on economies, beyond the immediate region, will be through higher commodity prices, mainly energy (natural gas and oil), but also food (wheat) and metals. The main concerns for investors are: what impact will this have on economic growth, central bank policy and corporate profitability. At present our expectation is that the conflict may continue for several months, but we are hopeful that it will not escalate further or expand into a broader regional or global conflict. This means the economic impact will primarily be felt through higher commodity prices, with the market already pricing in the expected supply disruption. There is a risk that sanctions, which have cut Russia off from global financial markets, destabilize global financial conditions, but we are optimistic that central banks will be quick to respond to any signs of stress.

Higher commodity prices will effectively act as a tax on household and businesses, reducing demand for other goods and services, and pushing up inflation. It will be relatively obvious for central banks to ignore commodities’ impact on inflation (which should be transitory) but more difficult for them to decide how much to tighten policy given inflationary pressures from other sources are strong but the growth outlook is now a lot more uncertain. Given economies were rebounding strongly before the conflict started, we think they will still grow at a robust rate, meaning central banks will remain committed to normalizing monetary policy, just more cautiously than before. So, expect 25 basis points (bps) rate hikes rather than 50bps jumps, getting to the same point in the end but taking a few months longer. This means we still expect government bond yields to rise from current levels, and credit products to remain under pressure (even if underlying asset quality remains sound). Uncertainty about the length and intensity of the conflict remains the biggest issue. That said, the meaningful sell off in credit products in March, particularly in investment grade bonds is already pricing in a significant deterioration in economic conditions and in the case of euro denominated credit, almost recessionary economic conditions. Central banks have their work cut out for them but for now we expect central banks will follow through on their pre-invasion monetary tightening strategies.

The impact on corporate profitability is likely to be varied. The Energy, Commodities and Defense sectors are likely to benefit (not that we see a lot of this being priced in at present, especially in emerging markets); Healthcare and Telecoms will be least affected, and for Utilities it will depend on their exact regulatory and commodity exposure. Both Industrials and Consumer sectors will be negatively affected, but at least they were experiencing strong demand going into the crisis. However, there is no denying that the impact will be negative, with European corporates more affected.

Still, we think the growth backdrop is strong enough that default risk remains low given the extent corporates have repaired their balance sheets over the last two years. We therefore think corporate credit remains attractive and have a preference for high yield over investment grade. The conflict has also created opportunities in emerging markets, which have repriced cheaper due to liquidity and contagion reasons; many of them ought to be beneficiaries of higher commodity prices, but this is not reflected in the recent price action. The U.S. dollar and Swiss franc have benefitted as “safe havens” and are likely to remain strong during this uncertain tumultuous period. Longer term the U.S. dollar looks stretched and may explain why it has not risen even by more than it already has.

Developed Market Rate/ Foreign Currency

MONTHLY REVIEW

The month began with more signs of persistent inflation and further hawkish shifts from central banks, leading to a broad increase in rates. That narrative was interrupted as the attention shifted to Russia’s invasion of Ukraine, which disrupted global markets across asset classes. The initial increase in rates reversed, as a flight to safety supported government bonds and markets anticipated that central banks may move slowly when removing accommodative policies. The U.S. dollar appreciated due to its “safe-haven” status. Inflation remains a key theme, with data continuing to surprise to the upside, and the outlook exacerbated by higher commodity prices due to the Ukraine conflict.1

OUTLOOK

Developed economy central banks face a more difficult job, as they now need to balance increased downside economic risk against stronger than expected inflation. Most economies are mainly affected by Ukraine through higher commodity prices, which are effectively a tax on consumers and will reduce demand for other goods. There are also concerns about what sanctions will do to global financial liquidity conditions.

We still expect central banks to normalise policy. However, the pace is likely to be more cautious than previously speculated. This should mean that government bond yields still rise through 2022, as the conflict is likely to delay the pace of normalisation for three to six months rather than stop it. We have limited conviction on the direction of currencies.

Emerging Market Rate/ Foreign Currency

MONTHLY REVIEW

Emerging markets debt (EMD) experienced a large increase in volatility upon Russia’s decision to invade Ukraine towards the end of the month. Broader global markets did experience a related increase in volatility, but really focused on Russian and Ukrainian assets as well as those in the immediately surrounding countries. Local Russian fixed income assets were down an estimated 70% in value. U.S. dollar-denominated corporate debt,2 local sovereign debt,3 and U.S. dollar- denominated sovereign debt were also down.4

OUTLOOK

The outcome of this situation is quite fluid and path dependent, including the degree of broader geopolitical impact and contagion into global capital markets as large scale sanctions begin to take effect. Various macro implications include further global inflation as a result of supply side shocks and the West’s tolerance level for autocratic regimes.

Corporate Credit

MONTHLY REVIEW         

Investment grade corporate credit spreads widened in February with general market volatility continuing amidst macro disruptors. Government bond yields rose globally. The Russian invasion of Ukraine was the major news event in February where the sentiment is fluid reflecting each new piece of information. Other news impacting markets included upside surprises to the global inflation data. Corporate news in the month was dominated by fourth quarter reporting.5

The high yield corporate market remained weak in February. Concern over elevated inflation readings and increasingly hawkish messaging from the U.S. Federal Reserve remained a consistent theme.

The Russian invasion of Ukraine injected additional volatility into the market. Over the month, yields rose by 35 bps and spreads widened.6

Global convertibles continued the worst start to a year on record as investors weighed the impact of rising rates and of war in Ukraine. Issuance was low in down markets in February. Growth sectors lagged again while only Energy and Materials rallied.7

The senior floating-rate corporate loan market lost ground in February driven by market volatility. Despite the modestly negative performance, loans fared better relative to other capital markets, including equities and high-yield corporate bonds.8

OUTLOOK

Looking forward with valuations significantly above the long run average for spreads and nearing the wides of the fourth quarter 2018, we see value opportunities but expect volatility given the near-term uncertainty of geo-politics and the limited liquidity available if flows increase.

Securitized Products

MONTHLY REVIEW

Agency MBS underperformed again in February. Spreads are now wider than pre-pandemic levels as the market anticipates the end of quantitative easing and potentially the beginning of quantitative tightening, but agency MBS spreads could widen further from supply-demand pressure. U.S. non- agency RMBS spreads were also wider across most residential sectors in February, as nearly all risk assets cheapened given concerns about inflation, central bank policies and geo-political events. U.S. ABS spreads were also wider, but fundamental performance remains strong and issuance remained high through the month.9

OUTLOOK

We believe the securitized market still offers a unique combination of low duration, attractive yields, and solid credit fundamentals. We remain constructive on securitized credit and cautious on agency MBS and interest rate risk.

 
 

The views and opinions expressed are those of the Portfolio Management team as of March 2022 and are subject to change based on market, economic and other conditions. Past performance is not indicative of future results.

1 Source: Bloomberg. Data as of February 28, 2022.

2 Source: J.P. Morgan CEMBI Broad Diversified Index. Data as of February 28, 2022.

3 Source: JPM EMBI Global Diversified Index. Data as February 28, 2022.

4 Source: J.P. Morgan GBI-EM Global Diversified Index. Data as of February 28, 2022.

5 Source: Bloomberg. Data as of February 28, 2022

6 Source: Bloomberg U.S. Corporate High Yield Index. Data as of February 28, 2022.

7 Source: Refinitiv Global Convertibles Focus Index. Data as of February 28, 2022.

8 Source: S&P/LSTA Leveraged Loan Index. Data as of February 28, 2022.

9 Source: Bloomberg, as of February 28, 2022.

 
 

Risk Considerations

Diversification neither assures a profit nor guarantees against loss in a declining market.

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is  difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in a portfolio. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Certain U.S. government securities purchased by the strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. High-yield securities (junk bonds) are lower-rated securities that may have a higher degree of credit and liquidity risk. Sovereign debt securities are subject to default risk. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default, and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. The currency market is highly volatile. Prices in these markets are influenced by, among other things, changing supply and demand for a particular currency; trade; fiscal, money and domestic or foreign exchange control programs and policies; and changes in domestic and foreign interest rates. Investments in foreign markets entail special risks such as currency, political, economic and market risks. The risks of investing in emerging market countries are greater than the risks generally associated with foreign investments. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, and correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Due to the possibility that prepayments will alter the cash flows on collateralized mortgage obligations (CMOs), it is not possible to determine in advance their final maturity date or average life. In addition, if the collateral securing the CMOs or any third-party guarantees are insufficient to make payments, the portfolio could sustain a loss.

 
 
 
The Global Fixed Income team follows a seamless process with a global outlook. They seek to identify and capture the potential value in situations where the market's implied forecasts are extreme.
 
 
 
Featured Fund
 
 
 
 
 

DEFINITIONS

Basis point: One basis point = 0.01%.

INDEX DEFINITIONS

The indexes shown in this report are not meant to depict the performance of any specific investment, and the indexes shown do not include any expenses, fees or sales charges, which would lower performance. The indexes shown are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

“Bloomberg®” and the Bloomberg Index/Indices used are service marks of Bloomberg Finance L.P. and its affiliates, and have been licensed for use for certain purposes by Morgan Stanley Investment Management (MSIM). Bloomberg is not affiliated with MSIM, does not approve, endorse, review, or recommend any product, and does not guarantee the timeliness, accurateness, or completeness of any data or information relating to any product.

The Bloomberg Euro Aggregate Corporate Index (Bloomberg Euro IG Corporate) is an index designed to reflect the performance of the euro-denominated investment-grade corporate bond market.

The Bloomberg Global Aggregate Corporate Index is the corporate component of the Bloomberg Global Aggregate index, which provides a broad-based measure of the global investment-grade fixed income markets.

The Bloomberg U.S. Corporate High Yield Index measures the market of USD-denominated, non-investment grade, fixed-rate, taxable corporate bonds. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. The index excludes emerging market debt.

The Bloomberg U.S. Corporate Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable, corporate bond market.

The Bloomberg U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage. Introduced in 1985, the GNMA, FHLMC and FNMA fixed-rate indexes for 30- and 15-year securities were backdated to January 1976, May 1977 and November 1982, respectively. In April 2007, agency hybrid adjustable-rate mortgage (ARM) pass-through securities were added to the index.

Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.

Euro vs. USD—Euro total return versus U.S. dollar.

German 10YR bonds – Germany Benchmark 10-Year Datastream Government Index; Japan 10YR government bonds – Japan Benchmark 10-Year Datastream Government Index; and 10YR U.S. Treasury – U.S. Benchmark 10-Year Datastream Government Index.

The ICE BofAML European Currency High-Yield Constrained Index (ICE BofAML Euro HY constrained) is designed to track the performance of euro- and British pound sterling-denominated below investment-grade corporate debt publicly issued in the eurobond, sterling.

The ICE BofAML U.S. Mortgage-Backed Securities (ICE BofAML U.S. Mortgage Master) Index tracks the performance of U.S. dollar-denominated, fixed-rate and hybrid residential mortgage pass-through securities publicly issued by U.S. agencies in the U.S. domestic market.

The ICE BofAML U.S. High Yield Master II Constrained Index (ICE BofAML U.S. High Yield) is a market value-weighted index of all domestic and Yankee high-yield bonds, including deferred-interest bonds and payment-in-kind securities. Its securities have maturities of one year or more and a credit rating lower than BBB-/Baa3, but are not in default.

The ISM Manufacturing Index is based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys.

Italy 10-Year Government Bonds – Italy Benchmark 10-Year Datastream Government Index.

The JP Morgan CEMBI Broad Diversified Index is a global, liquid corporate emerging markets benchmark that tracks U.S.-denominated corporate bonds issued by emerging markets entities.

The JPMorgan Government Bond Index – emerging markets (JPM local EM debt) tracks local currency bonds issued by emerging market governments. The index is positioned as the investable benchmark that includes only those countries that are accessible by most of the international investor base (excludes China and India as of September 2013).

The JPMorgan Government Bond Index Emerging Markets (JPM External EM Debt) tracks local currency bonds issued by emerging market governments. The index is positioned as the investable benchmark that includes only those countries that are accessible by most of the international investor base (excludes China and India as of September 2013).

The JP Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets and is an expanded version of the EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans and eurobonds with an outstanding face value of at least $500 million.

The JP Morgan GBI-EM Global Diversified Index is a market-capitalization weighted, liquid global benchmark for U.S.-dollar corporate emerging market bonds representing Asia, Latin America, Europe and the Middle East/Africa.

JPY vs. USD – Japanese yen total return versus U.S. dollar.

The Nikkei 225 Index (Japan Nikkei 225) is a price-weighted index of Japan’s top 225 blue-chip companies on the Tokyo Stock Exchange.

The MSCI AC Asia ex-Japan Index (MSCI Asia ex-Japan) captures large- and mid-cap representation across two of three developed markets countries (excluding Japan) and eight emerging markets countries in Asia.

The MSCI All Country World Index (ACWI, MSCI global equities) is a free float-adjusted market capitalization weighted index designed to measure the equity market performance of developed and emerging markets. The term “free float” represents the portion of shares outstanding that are deemed to be available for purchase in the public equity markets by investors. The performance of the Index is listed in U.S. dollars and assumes reinvestment of net dividends.

MSCI Emerging Markets Index (MSCI emerging equities) captures large-and mid-cap representation across 23 emerging markets (EM) countries.

The MSCI World Index (MSCI developed equities) captures large and mid-cap representation across 23 developed market (DM) countries.

Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector.

The Refinitiv Convertible Global Focus USD Hedged Index is a market weighted index with a minimum size for inclusion of $500 million (U.S.), 200 million (Europe), 22 billion Yen, and $275 million (Other) of Convertible Bonds with an Equity Link.

The Russell 2000® Index is an index that measures the performance of the 2,000 smallest companies in the Russell 3000 Index.

The S&P 500® Index (U.S. S&P 500) measures the performance of the large-cap segment of the U.S. equities market, covering approximately 75 percent of the U.S. equities market. The index includes 500 leading companies in leading industries of the U.S. economy.

S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index seeks to measure the value of residential real estate in 20 major U.S. metropolitan areas: Atlanta, Boston, Charlotte, Chicago, Cleveland, Dallas, Denver, Detroit, Las Vegas, Los Angeles, Miami, Minneapolis, New York, Phoenix, Portland, San Diego, San Francisco, Seattle, Tampa and Washington, D.C.

The S&P/LSTA U.S. Leveraged Loan 100 Index (S&P/LSTA Leveraged Loan Index) is designed to reflect the performance of the largest facilities in the leveraged loan market.

The S&P GSCI Copper Index (Copper), a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark for investment performance in the copper commodity market.

The S&P GSCI Softs (GSCI soft commodities) Index is a sub-index of the S&P GSCI that measures the performance of only the soft commodities, weighted on a world production basis. In 2012, the S&P GSCI Softs Index included the following commodities: coffee, sugar, cocoa and cotton.

Spain 10-Year Government Bonds – Spain Benchmark 10-Year Datastream Government Index.

The Thomson Reuters Convertible Global Focus USD Hedged Index is a market weighted index with a minimum size for inclusion of $500 million (U.S.), 200 million euro (Europe), 22 billion yen, and $275 million (Other) of convertible bonds with an equity link.

U.K. 10YR government bonds – U.K. Benchmark 10-Year Datastream Government Index. For the following Datastream government bond indexes, benchmark indexes are based on single bonds. The bond chosen for each series is the most representative bond available for the given maturity band at each point in time. Benchmarks are selected according to the accepted conventions within each market. Generally, the benchmark bond is the latest issue within the given maturity band; consideration is also given to yield, liquidity, issue size and coupon.

The U.S. Dollar Index (DXY) is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners’ currencies.

The Chicago Board Options Exchange (CBOE) Market Volatility (VIX) Index shows the market’s expectation of 30-day volatility.

There is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

A separately managed account may not be appropriate for all investors. Separate accounts managed according to the particular Strategy may include securities that may not necessarily track the performance of a particular index. A minimum asset level is required.

For important information about the investment managers, please refer to Form ADV Part 2.

The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Furthermore, the views will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date of publication. The views expressed do not reflect the opinions of all investment personnel at Morgan Stanley Investment Management (MSIM) and its subsidiaries and affiliates (collectively “the Firm”), and may not be reflected in all the strategies and products that the Firm offers.

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Charts and graphs provided herein are for illustrative purposes only. Past performance is no guarantee of future results.

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For professional investors, this document is circulated or distributed for informational purposes only. For those who are not professional investors, this document is provided in relation to Morgan Stanley Investment Management (Japan) Co., Ltd. (“MSIMJ”)’s business with respect to discretionary investment management agreements (“IMA”) and investment advisory agreements (“IAA”). This is not for the purpose of a recommendation or solicitation of transactions or offers any particular financial instruments. Under an IMA, with respect to management of assets of a client, the client prescribes basic management policies in advance and commissions MSIMJ to make all investment decisions based on an analysis of the value, etc. of the securities, and MSIMJ accepts such commission. The client shall delegate to MSIMJ the authorities necessary for making investment. MSIMJ exercises the delegated authorities based on investment decisions of MSIMJ, and the client shall not make individual instructions. All investment profits and losses belong to the clients; principal is not guaranteed. Please consider the investment objectives and nature of risks before investing. As an investment advisory fee for an IAA or an IMA, the amount of assets subject to the contract multiplied by a certain rate (the upper limit is 2.20% per annum (including tax)) shall be incurred in proportion to the contract period. For some strategies, a contingency fee may be incurred in addition to the fee mentioned above. Indirect charges also may be incurred, such as brokerage commissions for incorporated securities. Since these charges and expenses are different depending on a contract and other factors, MSIMJ cannot present the rates, upper limits, etc. in advance. All clients should read the Documents Provided Prior to the Conclusion of a Contract carefully before executing an agreement. This document is disseminated in Japan by MSIMJ, Registered No. 410 (Director of Kanto Local Finance Bureau (Financial Instruments Firms)), Membership: The Japan Securities Dealers Association, the Investment Trusts Association, Japan, the Japan Investment Advisers Association and the Type II Financial Instruments Firms Association.

 

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