By Aaron Saldanha and Divya Chowdhury
(Reuters) – The U.S. Federal Reserve could tighten monetary policy as soon as the second half of 2020, provided inflation even modestly picks up, Guggenheim Partners Global Chief Investment Officer Scott Minerd said on Wednesday.
Minerd said he expects the U.S. yield curve <0#USBMK=> to steepen if economic growth beats expectations, and believes fixed income securities outside the respective benchmark could provide on average up to 100 basis points in incremental yield this year.
Minerd, whose firm manages $265 billion, wrote https://www.guggenheiminvestments.com/perspectives/global-cio-outlook/global-central-banks-fueling-a-ponzi-market this week about deteriorating quality in corporate bond markets, saying he expects 15% to 20% of BBB-rated bonds ($500 billion to $660 billion-worth) to be downgraded to the high-yield category in the next wave of downgrades.
Below are excerpts of the chat, conducted on the sidelines of the World Economic Forum’s annual meeting in Davos, Switzerland:
Question (Q) – Given your view on corporate bonds, how are you positioned and what portion of Guggenheim’s total assets is aimed at this outcome (mass BBB downgrades)?
Answer (A) – About 20% of fixed income allocation is in investment grade corporate bonds. The majority is single A-rated or higher.
The balance of the portfolio is being invested in longer duration, high quality taxable municipal bonds, about 25% in government and agencies, 25% in asset backed securities. Under 5% of the portfolio has exposure to emerging markets.
Q – What’s your 2020 outlook for U.S. growth and markets?
A – Economic growth will surprise to upside and real GDP (growth) could exceed 3%. Ultimately, long-term rates will rise with yield on the 10-year note <US10YT=RR> (rising) to around 2.25% toward 2020’s second half.
We expect credit strains due to over-leveraged companies to translate to a higher spread between corporate debt yields and U.S. Treasury yields.
If economic growth accelerates like I expect, then the yield curve will steepen and the Fed may return to tightening policy in 2020’s second half.
Q – Given that the spillover of unconventional monetary policies of the European Central Bank and Bank of Japan are likely to anchor U.S. yields lower, how can U.S. yields rise barring improved US economic data?
A – I agree (with) international rates low and many in negative territory, it’s difficult to see how long-term U.S. rates could rise dramatically. That’s why I think the 10-year note’s yield will not exceed 2.25% for the balance of U.S. expansion.
Nevertheless, as U.S. economic activity picks up and given a fairly modest rise in Personal Consumption Expenditures (PCE) (Price Index) of 0.3% or 0.4 %, the Fed will act to restrain inflation. Once PCE exceeds 2.25%, the Fed will act by raising short-term rates.
Q – In your core plus strategy, how do you evaluate quality among securities not included in the benchmark? What do you expect the yield pick up on these securities over their peers in the benchmark to average in 2020?
A – Not being included in the benchmark does not imply they are in some way inferior to benchmark securities. In fact, our view is they are probably safer.
Nevertheless, even though safer, they offer higher yields than most securities in the benchmark. On balance, there could be up to 100 basis points of incremental yield on average (in 2020).
(Reporting by Divya Chowdhury in Davos, Aaron Saldanha in Bengaluru)