Fixed income investing today is very different from two or even three years ago. Then, we were in a U.S. economy with about 1% percent inflation and the potential risk of deflation. Now the U.S. is nearing a 2% inflation rate with the risk that more fiscal policy or some pullback of monetary policy could cause inflation to be a bit less, or a bit more, than 2%. Today’s much more uncertain inflationary dynamic means it’s more difficult to know where interest rates are heading than it was in the recent past. The fixed income market is also more volatile now than previously.
In this market environment it may be harder to know where to take interest rate exposure, but generating fixed income returns is still possible. Investors just have to think more carefully about where they make their allocations, taking into account relative values and risk around the world, around the capital stack, and across asset classes. Diligent research and analysis are critical to properly adding diversification and managing risks in portfolios. Against this backdrop, I see a number of potential investing opportunities, as I share in a recent Q&A piece on “Creating durable fixed income portfolios for an evolving market.”
I see interesting opportunities for taking credit risk in selected emerging markets, particularly in markets such as Brazil and Mexico, where rates could come down. Compared to 20 years ago—or even just 10 years ago—emerging markets are in much better shape. Their reserves are higher, their leverage is lower, and they are relatively cheap compared to other parts of the world. Monetary policy has pushed rates in Europe to extremely low levels, which has pulled down global interest rates to distorted levels. But emerging markets have actually not been tethered to European rates.
High-cash flow securitized assets markets present attractive opportunities to generate income, in my view. Technicals in the asset-backed market have been strong and fundamentals have been improving, particularly in areas like housing and commercial real estate. I believe investors can potentially build a durable portfolio with core foundations centered around assets with strong technicals, fundamentals, and cash flows, such as securitized assets, while also taking some credit risk where it looks intriguing, such as in select emerging markets.