Fixed income opportunities in a chaotic and uncertain world

We believe the Trump administration has realised that transforming the US economy into the world’s workshop is not feasible. However, this doesn’t mean that US security concerns over certain key production lines have abated. It’s highly likely that the US will continue to pursue self-sufficiency or, at least de-risk supply chains in key goods such as semiconductors and pharmaceuticals. It’s unlikely that the US will aim to gain a dominant share of the market for t-shirts, toys, dolls or other such low value items. 

The importance of China

This trade war has highlighted how embedded Chinese products and components are in Western industry and it could be argued that the US is also at a loss in terms of how to respond.

There is no denying that some of the national security concerns that the US has often cited as a base to impose tariffs on their partners are real. The rise of China from an exporter of low value-added consumer products to industrial powerhouse with strong competitiveness in key sectors like semiconductors, automotive or heavy industrial machinery can’t be ignored. This poses a risk for Western nations and a great challenge for countries with large exports in such industries, especially in Europe.

US economy: a “bifurcated equilibrium”

US growth may face a bumpy path ahead in the coming quarters because of policy uncertainty and trade volatility, but Trump taking the off-ramp with regards to the de facto trade embargo with China means that something approaching a sharp slowdown or perhaps even a recession is now highly unlikely. We expect the impact from tariffs on US inflation this year to be a little lower than feared earlier and equally growth expectations should be a little higher.

That said there are still some pre-existing areas of weakness in the US economy that are worth monitoring in the medium term. We would define the current environment in the US as a “bifurcated equilibrium”. This can be seen amongst consumers (top 10% account for as much as 50% of consumption) and the stock market (large caps outperform small caps). We see several scenarios where the US Federal Reserve might feel compelled to cut more than currently priced, yet residual inflation uncertainty will likely make the Federal Open Markets Committee (FOMC) more reactive than proactive.

We expect a shift in focus from the more painful items of Trump’s agenda, such as trade, to the more positive ones for risk, such as fiscal policy, deregulation and the potential resolution of simmering geopolitical conflicts.

When it comes to US fiscal policy, we have reassessed our stance. Recent proposals show spending increases will exceed reductions. The overall trajectory now appears expansionary, making the long end Treasuries less attractive amid mounting scrutiny of US government finances.

EU and UK: weak growth might persist

The temporary truce on the tariff front augurs well for the US but we expect the EU and the UK to be at the receiving end if cheap Chinese goods flood into their markets. This could particularly exacerbate the problems faced by Europe’s manufacturing sector, which is struggling to compete with the US and Asian countries. We expect growth to disappoint both in the EU and the UK. The ongoing global trade war, along with lower oil prices and their currency’s strength against the dollar, may contribute to disinflation. That could drive the European Central Bank and the Bank of England to further cut interest rates.

Fixed income opportunities

We see this environment as positive for both rates and spreads. Government bonds might benefit from sharper cuts in rates than what’s currently priced. For now, duration in developed markets outside the US is preferable, along with the front end and belly of the US curve. Certain emerging markets, such as Brazil or Mexico, also offer interesting opportunities in the rates space.

Risk assets are today in a stable equilibrium, given several different forces at play. Yet, credit spreads are tight, and the overall macroeconomic picture is not great. We continue to prefer defensive sectors, secured bonds and short duration paper, with several high conviction themes.

Strategy specific risks

• Share Class Hedging Risk - The share class hedging process can cause the value of investments to fall due to market movements, rebalancing considerations and, in extreme circumstances, default by the counterparty providing the hedging contract.
• Interest Rate Risk - The Strategy can invest in assets whose value is sensitive to changes in interest rates (for example bonds) meaning that the value of these investments may fluctuate significantly with movement in interest rates.e.g. the value of a bond tends to decrease when interest rates rise
• Pricing Risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
• Contingent convertible bonds - The Strategy may invest in contingent convertible bonds. These instruments may experience material losses based on certain trigger events. Specifically these triggers may result in a partial or total loss of value, or the investments may be converted into equity, both of which are likely to entail significant losses.
• Credit Risk - The issuer of a bond or a similar investment within the Strategy may not pay income or repay capital to the Strategy when due.
• Derivative risk - the Strategy may use derivatives to reduce costs and/or the overall risk of the Strategy (this is also known as Efficient Portfolio Management or "EPM"). Derivatives involve a level of risk, however, for EPM they should not increase the overall riskiness of the Strategy.
• Liquidity Risk (general) - During difficult market conditions there may not be enough investors to buy and sell certain investments. This may have an impact on the value of the Strategy.
• Counterparty Default Risk - The risk of losses due to the default of a counterparty on a derivatives contract or a custodian that is safeguarding the Strategy's assets.
• Sub investment grade bonds - The Strategy may invest a significant portion of its assets in securities which are those rated below investment grade by a credit rating agency. They are considered to have a greater risk of loss of capital or failing to meet their income payment obligations than higher rated investment grade bonds.
• Charges from capital - Some or all of the Strategy’s charges are taken from capital. Should there not be sufficient capital growth in the Strategy this may cause capital erosion.
  
  

Important information

The information contained in this market commentary is intended solely for members of the media and should not be relied upon by private investors or any other persons to make financial decisions.

This communication, including any data and views in it, is not a financial promotion as defined in MiFID II. It does not constitute an invitation to invest or investment advice in any way. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.

Market and exchange rate movements can cause the value of an investment to fall as well as rise, and investors may get back less than originally invested.

The views expressed are those of the Fund Manager at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.

Issued in the UK by Jupiter Asset Management Limited, registered address: The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ is authorised and regulated by the Financial Conduct Authority. Issued in the EU by Jupiter Asset Management International S.A.  registered address: 5, Rue Heienhaff, Senningerberg L-1736, Luxembourg which is authorised and regulated by the Commission de Surveillance du Secteur Financier.