Vivek Bommi: We started the year really worried about growth, inflation and the impact to central banks. But, recently, we had the added dimension of the Russia/Ukraine conflict throwing uncertainty into that. Can you unpack all this for us and tell us what it means for fixed-income investors?
John Taylor: Recent events have just added an additional inflationary impulse into an already high-inflation environment. And that’s really prompted a pretty significant shift from nearly all of the central banks to become a lot more hawkish about the outlook.
VB: Now, you’ve seen differing central bank action. Can you explain that for us?
JT: So, I think the biggest divergence is really between emerging markets and developed markets. [As far as] the emerging markets, central banks just didn’t have the luxury of waiting to see whether inflation was transitory or not. They don’t have the credibility to do that.
So, they’ve had to react a lot sooner—to the extent that many of those central banks were either finished or very close to finishing their rate hiking cycle before the likes of the Fed or the ECB (European Central Bank) have even started. But, now, with this additional inflationary impulse, it’s likely that they might need to do a little bit more than they were anticipating.
VB: Even within the developed-market space, you’re really starting to see divergence as well, right?
JT: So, in the US, it’s probably where inflation has been the highest, but there are other parts of the world where inflation is still relatively low—be that Australia or Asia. And so, the great contrast is probably between Europe and the US. On the face of it, they look like they have some similarities—higher headline inflation.
But when you look a little bit deeper, the underlying core inflation measures are somewhat different. Europe is somewhat elevated relative to the past but well below what we see in the US. And wage inflation, which is pretty high in the US, is pretty much nonexistent in Europe. And that should give us and the central banks greater confidence that, over the medium term, inflation falls back relatively quickly toward the targets in Europe—whereas, in the US, it’s going to take a lot more effort from the Fed to deliver that outcome.
VB: So, while they’re moving in a similar direction, it’s different speeds, right?
VB: Now, what do you think, ultimately, the ECB does, given all the uncertainty that’s going on with Russia/Ukraine?
JT: So, I think it was clear from a few months ago that the ECB wanted to use this opportunity to get out of negative interest rates. We went into negative interest rates back in 2014 and it was viewed as very much a short-term measure. Eight years later, we’re still in them.
So, with other central banks around the world—like the Fed and the Bank of England—doing more significant rate rises over the next year or so, this really was an opportunity for the ECB to get out of negative interest rates. At which point, if they need to add stimulus at some point in the future, that was much more likely to come in the form of quantitative easing (QE), rather than rate cuts back into negative territory again.
VB: And, if they do go down that path of quantitative easing again, what sort of parts of the market do benefit?
JT: Well, I think quantitative easing has shown itself to be very supportive for peripheral Europe and anything with a sovereign spread—but also, in terms of the credit markets as well.
So, I’ll ask that question as well. Given the current outlook, are there areas of the credit markets that we want to stay away from? And, on the flip side, what are the areas that we really think should be attractive at this point?
VB: You know, I think parts of the market that really rely on high growth are probably more susceptible. So, when you think [about it], certain parts of the emerging-markets complex probably [are] a little bit more aligned on growth.
But where we see actually good value right now is in developed-markets high yield, because we had a default cycle, almost just two years ago with COVID. The companies that are left are in the best shape they’ve ever been.
And, more notably also, the companies left, they’re not really heavy manufacturing companies that actually rely on a lot of energy as an input. You know, large sectors include healthcare, telecom, cable, consumer nondiscretionary. These are just companies that, while energy impacts them, it’s not to a significant level to cause any sort of credit deterioration.
And so, while we’ve seen credit spreads get elevated in this environment, we don’t think this actually leads to any sort of increase in defaults that we’re currently seeing.
JT: So, contrast now to a year ago, when every central bank around the world had cut interest rates to zero or negative and was doing QE. Fast forward today and they were sort of pulling that QE away, as well as hiking interest rates. [Those] widening credit spreads [are] really driven by that more so than deterioration in fundamentals. And moreover, you’ve also seen a rise in government bond yields as well. So really, from an investor’s standpoint, this high-yield opportunity in credit really should be viewed as a buying opportunity.
VB: The level of double B’s [is] the highest it’s ever been. The level of triple C’s is, frankly, the lowest it’s ever been. And again, we’re still seeing more upgrades than downgrades within the market right now. So, we think actually right now—given where spreads are priced, given the actual yields you’re seeing—that is a pretty good entry point.
Vivek Bommi is Head of European Fixed Income and Director of European and Global Credit, and John Taylor is Director of Global Multi-Sector at AllianceBernstein.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.