The US Federal Reserve

Amid mixed economic signals and rising global risks, the Federal Reserve (Fed) is holding interest rates steady and staying flexible as it monitors how conditions develop.

For the third consecutive meeting, the Federal Open Market Committee (FOMC) kept the target range for the fed funds rate unchanged at 4.25% to 4.50%. This decision was widely expected, as was Fed Chair Powell’s cautious stance on providing definitive guidance amid extreme trade and fiscal policy uncertainty. The committee’s prepared statement included changes that conveyed a continued sense of uncertainty around the economic outlook and heightened risks of both higher unemployment and rising inflation.

Nicholas Mastroianni, portfolio manager at Western Asset (part of Franklin Templeton) said, “Looking ahead, incoming data will be critically important in shaping the near-term trajectory of monetary policy. By the time of the next Fed meeting on June 18, the committee will have only one additional labor market report and two more inflation readings to consider.

“Given Chair Powell’s insistence that further easing would require clear evidence of deterioration in the hard data, it is difficult to foresee a resumption of the rate-cutting cycle in June absent more pronounced signs of stress among consumers and businesses. In our view, this suggests the Fed will remain on hold through the summer, as policymakers await greater clarity regarding ongoing developments in trade and tax policy.

“Our base case anticipates that slowing growth and moderating services inflation will become more apparent in the hard data by the September FOMC meeting, at which point the Fed will likely be able to resume the rate-cutting cycle that it initiated last year.

“In the interim, high-quality fixed income, particularly with exposure to the intermediate part of the yield curve continues to offer attractive yields and a compelling risk/return profile. Should trade policy developments impact the hard data more quickly or more forcefully than currently expected, we believe the Fed is well positioned to respond accordingly.”

The post For the Fed, it’s time to wait and see appeared first on AdviserVoice.

Michael Buchanan

In its most recent analysis, Western Asset, part of the Franklin Templeton group, highlights its base case calls for further weakening of global growth and further declines in inflation with a greater emphasis on services disinflation.

“Goods price inflation is running modestly below pre-pandemic levels, but with ongoing deflationary pressures from Asia, it’s hard to see a meaningful persistent uptick going forward. Services inflation remains elevated, but wage pressures are abating as job markets soften and service sector demand is slowing. Headline inflation is close to target in most advanced economies, which has allowed central banks to reduce policy rates as their inflation concerns lessen while growth concerns rise,” notes Western Asset chief investment officer Michael Buchanan.

Growth is slowing in the US and remains moribund in the rest of the world. At the same time lower policy rates and the recent Chinese stimulus package should lessen recessionary fears.

“We remain overweight to interest-rate duration, but less so as rates have fallen, and markets have moved closer to our base case. Spread sectors have performed well and we expect this to continue if the downward growth trajectory remains gentle and services disinflation continues. However, valuations have less yield advantage now to offset potential macro and political risks going forward. Emerging market (EM) debt appears to remain attractive fundamentally, but both internal and external political risks have hampered performance in some countries.”

“In Australia progress on inflation remains slow, but there are signs of progress with the labour market loosening and wages growth rolling over. The RBA remains hawkish to encourage restraint, but we expect the conditions to allow them to start a shallow easing cycle in early 2025. Growth is slow, but tax cuts from mid-year will help to rebuild buffers.”

Read the report.

The post The big picture: Western Asset’s latest insights on economic drivers and credit markets for fixed-income investor fourth quarter 2024 appeared first on AdviserVoice.

Felicity Walsh

Western Asset Management, a Franklin Templeton company, is pleased to announce that the Western Asset Enhanced Income Fund has received an inaugural Recommended rating from Zenith Investment Partners.

Western Asset Enhanced Income Fund invests in a diversified portfolio of Australian and global fixed interest securities and focusses on adding value through active management of duration, sector and security selection.

“This rating is recognition of the team’s hard work to generate superior returns for our investors via this enhanced income strategy,” Head of Asia Pacific Investment Management at Western Asset Management, Anthony Kirkham, said.

Felicity Walsh, Managing Director of Franklin Templeton Australia and New Zealand, added, “The Zenith rating underscores our commitment to delivering innovative and high-quality investment solutions. It is a testament to the diligent efforts of the Western Asset investment team and their unwavering focus on creating value for our clients in Australia.”

In its report Zenith said it held a positive view of both the investment team and its investment process and that the fund is an attractive option in the Australian corporate debt sector.

“Zenith considers the portfolio construction process to be sound, effectively synthesising both the outlook of the global investment committees and the fundamental credit analysis to construct a portfolio that reflects the team’s views,” the report said.

The team’s access to a network of global credit analysts that provide on-the-ground and real time surveillance of global corporate bonds positions the investment process for a competitive advantage.

The fund targets returns (before fees, charges and taxes) that exceed the Bloomberg AusBond Bank Bill Index by 1.5% to 2% per annum, when measured over rolling three-year periods, and has achieved this target excess return since its inception in 2021.

“Generating income is an increasingly important theme for investors right now, given the current economic environment and interest rate volatility globally. Our strategy is designed to meet this need by providing consistent and attractive income streams,” Kirkham explained.

Dedicated to active fixed income investing, Western Asset manages a range of strongly rated fixed income strategies for Australian investors.

Notably, the Western Asset Australian Bond Fund retained its ‘Highly Recommended’ rating from Zenith, a rating held by the fund since June 2016.

The Betashares Western Asset Australian Bond Fund, an exchange traded fund that seeks to replicate the strategy of the unlisted Western Asset Australian Bond Fund (ticker code BNDS), also retained its ‘Highly Recommended’ rating.

The post Western Asset Enhanced Income Fund receives inaugural Recommended Rating from Zenith appeared first on AdviserVoice.

Jonathan Costello, Client Service Executive at Western Asset, a global fixed income manager, says “Within fixed income markets, behavioural and structural inefficiencies exist that present opportunities for active managers to enhance returns. Various pitfalls of investing passively can also serve to increase risk, underscoring the importance of addressing these via active approaches to ensure fixed income’s defensive profile delivers to the best extent possible.”

The composition of the Australian fixed income market has changed dramatically over the past two decades. Whilst corporate debt outstanding has grown modestly, the sheer weight of Government and Semi-Government issuance has dwarfed corporate issuance and crowded out credit in the benchmark.

Costello adds “A similar outcome has transpired for the Supranational sector. Lower sector diversification, reduced exposure to credit and changes to the risk attributes of the index are the result.

“Passive investors have inherited lower corporate exposure and thus less yield buffer. In an investment grade dominated, high quality market, that additional yield buffer has proven to be a valuable tool against the negative impacts of rising rates, with a negligible increase in default risk.

“Increasing weights to these high-quality corporates without significantly increasing the risk of the portfolio, nor decreasing the average quality is possible through active management. Active managers can also position appropriately to maintain the attributes that investors are seeking in a core fixed income allocation; liquidity, defensive yield, correlation benefits and portfolio diversification.”

Recent data highlights the success that active managers have had within Australian Fixed Income

As shown in an S&P study, active management has been rewarded more often than not, over one and five-year periods. The report underscores active management’s success within Australian Fixed Income when viewed against other asset classes in which most managers have underperformed their benchmarks over 1, 3 and 5 year periods.

Source: S&P SPIVA Scorecard, Western Asset

“At Western Asset, we are confident that a consistent and time-honed process for identifying and exploiting the structural and behavioural inefficiencies of the market, offer risk-adjusted return enhancement opportunities that can deliver persistent outperformance for years to come,” notes Costello.

Read the report.

The post Active Australian fixed income continues to deliver attractive risk-adjusted returns appeared first on AdviserVoice.

Rate cuts from the Fed are likely as inflation falls.

Bond yields are higher than they’ve been in nearly 15 years, presenting investors with a variety of opportunities regarding fixed income.

The economic backdrop has also improved recently and is poised to be favourable in 2024 given falling inflation trends and subsequent likely rate cuts from the Fed according to Western Asset, a leading global fixed income manager and part of Franklin Templeton.

“What’s more, the breakdown of the traditional 60/40 (equities/bonds) portfolio that occurred over the last year or so—the historical negative correlations between stocks and bonds that help investors diversify—has largely been restored. Bonds once again can serve as a valuable hedge to equities and other risk assets.

“This is especially important as they offer compelling income in both nominal and real terms, which is well above recent equity yields (S&P dividend yield of 1.4%, as of year-end 2023). In other words, one of the most important qualities of fixed-income—the diversification benefit—appears to be functioning again.

“Finally, we believe current yields may be a reasonable indicator of what investors can earn over time,” notes the team at Western Asset.

The Western Asset portfolio managers add “Valuations have been most favourable for investors in last 15 years. With investment-grade credit currently yielding upwards of 5%, investors can beat cash rates and don’t need to reach for yield in riskier sectors any longer. In fact, today’s bond yields are also as attractive as they’ve been since the global financial crisis, according to Bloomberg. But one benefit in the aftermath of the recent rough patch is that yields and valuations have been restored—offering new opportunities for carry.

“Improving backdrop has created strong tailwinds for fixed income. The pace of global disinflation over the past six months has been remarkably swift, beyond most expectations. Inflation data in developed markets has already fallen close to the Fed’s 2% target, reflecting positive trends across major economies. We anticipate this broader disinflationary momentum will persist going forward, though likely in fits and starts as sticky components like goods prices and rents are likely to normalise at a more uneven cadence. Nevertheless, inflation moving closer to the Fed’s target increases the likelihood of interest rate cuts by the Fed in 2024 without a US recession.

“Traditional correlations are back offering diversification benefits. Market expectations for Fed rate cuts, aided by lower and more stable inflation—along with the Fed’s own admission it is likely nearing the end of its tightening cycle—has helped traditional asset class correlations normalise.

“Equities shot up in 2023, with the S&P 500 returning over 24% for the calendar year. Meanwhile, US Treasury had modestly positive returns (across the yield curve) and the Bloomberg US Aggregate Index rose 5.53%.

“In short, bonds are once again providing the ballast and the classic 60/40 investment strategy is working again. The evidence of this can be seen in the sharp decline of US Treasury yields in March 2023 (notably at the front end of the yield curve) following a “flight to quality” due to heightened concerns over US and European banking system stability.”

The post Higher rates, enhanced yield and restoration of traditional 60/40 (equities/bonds) portfolio underscores the appeal of bonds appeared first on AdviserVoice.

John Bellows

At the June 14 Federal Open Market Committee (FOMC) meeting the Federal Reserve (Fed) left rates unchanged but kept alive the possibility of raising rates again at upcoming meetings. Arguably, the committee even leaned into the prospect of higher rates, as a majority of officials now forecast at least two more rate rises in their base case.

“Over the past few weeks, there has been a fair amount of drama surrounding this possibility,” says John Bellows, Portfolio Manager, at Western Asset, part of the Franklin Templeton.

Bellows says: “The amount of drama surrounding whether the Fed raises rates again at one of the next few meetings seems disproportionate to its importance. The big picture is unlikely to change materially whether the Fed ends its hiking cycle now or after one or two more rate rises.

“Here we summarise how we see the big picture, and in our conclusion, we also offer a possible scenario as to how the drama will be resolved over the coming weeks and months.

“The size of the possible future rate rises is small relative to the hikes already made. Indeed, the difference is a full order of magnitude: the Fed has raised rates 500 basis points (bps) to date, as compared to another 50 bps of possible rate rises that are reflected in the median projection of FOMC participants. In terms of surprises relative to expectations, which is often what matters most for financial markets, the difference is even starker. The upside rates surprise in 2022 was one of the largest on record, corresponding with the worst year in the last 150 years for returns on US Treasury bonds.^[1] If the Fed were to raise rates again now, in contrast, the surprise would be much more modest, as markets already reflect some probability of such an event.

“While most of the rate rises are likely in the past, the full impact of monetary tightening is likely still ahead. In part this is due to the oft-repeated observation that monetary policy has “long and variable lags.” There is another factor, however, that may be just as important in the current environment. The Fed plans to hold interest rates above 5% for the coming few quarters, while inflation is expected to decline over the same period. Consequently, real interest rates are expected to continue increasing even if nominal rates do not.

“Fed officials are taking note. According to their own forecasts, a restrictive level of rates today will be even more restrictive a few months from now, with the economic impacts increasing as a result. This should give pause to any attempt to calibrate policy based on a handful of data prints.

“Elevated funding costs challenge sectors of the economy that rely on leverage. In certain instances the resulting stress contributes to nonlinear developments, which in turn raises uncertainty and exacerbates downside risks. The turmoil in regional banks is the most recent example. While the stability in this sector over the past few weeks has been encouraging, the risks have certainly not gone away. It’s notable that regional-bank equities still trade at a discount of more than 30% to their February prices. More broadly, the environment remains challenging.

“As long as funding costs remain above the rate of return on high-quality investments, banks will struggle to provide credit to the economy. Tighter lending standards is the minimum that should be expected, with risks tilted toward additional unforeseen stresses.”

Bellows says: “In summary, the following three points constitute the big picture. First, any future rate rises are likely to be small relative to the rate hikes already done. Second, the full impact of the rate rises has yet to be felt, as it will likely increase in the coming quarters when real interest rates increase further. Finally, the stress caused by elevated funding costs is significant and likely to continue. None of these considerations will change much, if at all, should rates end up closer to 5.5% instead of at their current level. The big picture is already set; the die has already been cast.

“While it may not affect the big picture, the Fed’s actions over the next few FOMC meetings will undoubtedly receive a lot of attention, so here we’ll offer a view on the most likely outcome. We expect the upcoming economic data to provide further evidence of slowing growth and ongoing disinflation. The consumer price data released yesterday was somewhat mixed with regard to inflation last month.

“Going forward the trend will likely be clearer: the decline in shelter inflation is set to continue, while the recent rise in goods inflation is likely to reverse, leaving core inflation broadly lower on net. The last few months of slowing labor demand is also likely to continue, as indicated by the forward-looking business surveys. On their own these trends may not cement a Fed decision. Taken together, however, we expect they will be enough to forestall the Fed from raising rates as much as indicated in the FOMC projections.”

——–

Endnotes:
[1] Zweig, J. “It’s the Worst Bond Market Since 1842. That’s the Good News.,” The Wall Street Journal, May 6, 2022.

The post Don’t let drama over next few Fed meetings distract from the big picture appeared first on AdviserVoice.

Felicity Walsh

The Western Asset Australian Bond Fund has been added to Colonial First State FirstChoice platform, giving investors and financial advisers greater access to a highly regarded, core fixed income investment option.

Launched in 1998, the AUD $1.4 billion Fund boasts a long-term track record compared to that of its benchmark Bloomberg AusBond Composite 0+yr Index, of delivering risk adjusted returns for its investors through a diversified portfolio of domestic fixed income assets including government and semi-government bonds, supranational, corporate credit, and mortgage and other asset-backed securities. ^[1]

The Fund is strategically positioned to deliver the crucial defensive ballast characteristics sought by investors in the asset class. Western Asset Head of Investment Management, Anthony Kirkham, says “the Fund is currently positioned to generate positive active returns for investors as market expectations for the pace of central bank policy rate tightening moderate.”^[2]

Kirkham says: “We would argue that the market has gone too far in factoring in rate rise expectations. The yield to maturity in the portfolio has grown substantially, to the highest level we have seen for some years. We continue to believe that the increasingly aggressive monetary policy track being priced in for the major central banks creates a greater likelihood of either an economic downturn or a moderation in policy setting projections. In either scenario, market yields would likely move lower again which would be expected to benefit those investing at current yields.”

Felicity Walsh, Franklin Templeton’s Managing Director and Head of Australia and New Zealand, says “ the Western Asset Australian Bond Fund is an industry recognised actively managed fixed income portfolio with a history of adding return relative to its benchmark since its inception, which is reflected in the many awards Western Asset has won.” ^[3]

Walsh says: “Western Asset’s active approach keeps the Fund’s interest rate positioning nimble and seeks to take advantage of volatility, credit opportunities and yield curve positioning.

We will continue to provide access to our award-winning products and capabilities to a wide range of investors in Australia and we are excited to continue our long and valued relationship with Colonial First State.”, Walsh notes.

——–

The post Western Asset Australian Bond Fund added to CFS FirstChoice appeared first on AdviserVoice.

Western Asset is among the largest global specialist fixed income managers, with global funds under management at A$685 billion. Western Asset is one of Franklin Templeton’s specialist investment managers

Anthony Kirkham, Head of Investment Management and Head of Australian Operations at Western Asset, says: “The situation we are in now is that Australian fixed income offers an attractive yield premium relative to other developed market bond markets. Investors are getting efficient returns for risk plus solid income generation.”

Western Asset’s view is that inflation remains challenging but it will ease into 2023. The RBA’s inflation forecasts recognise that headline inflation is likely to peak at around 6% in the second half of the year and trimmed mean inflation is likely to peak at around 4% before returning to the upper end of the target band of 2-3%.

As one of 11 countries with a AAA credit rating from the three international credit ratings agencies, backed by an attractive economic backdrop, Australia’s relatively lower inflation rate could suggest lower bond yields.

“We believe that market pricing has moved well beyond what is justified by fundamentals. Market pricing indicates the RBA will increase rates in consecutive meetings over the rest of this year, reaching 3% by year end, and continue into 2023, including multiple hikes greater than the standard 25 basis points,” Kirkham says.

Western Asset’s base case is that the RBA is likely to be more cautious in removing monetary policy accommodation. It is acutely aware of the impact of rising rates on consumer and business confidence, as well as the meaningful increase in the cost of living. Market pricing appears to be discounting these factors.

Kirkham says: “Our expectation is that the RBA’s projections for inflation entail a cash rate around 1.5%-1.75% by the end of the year – well below market expectations of around 3%.

“The bond market will benefit from evidence that the RBA is removing monetary accommodation in a responsible manner, without threatening economic growth, and also from a reduction in rates volatility globally.”

The post Australian bonds a compelling investment opportunity in today’s environment appeared first on AdviserVoice.

Western Asset is among the largest global specialist fixed income managers, with global funds under management at A$685 billion. Western Asset is one of Franklin Templeton’s specialised investment managers.

Michael J. Bazdarich, Product Specialist and Economist at Western Asset says: “The Bureau of Labor Statistics in the US announced in May that headline Consumer Price Index (CPI) inflation eased to 0.3% per month in April, down from 1.2% in March, while so-called core inflation widened to 0.6% in April from 0.3% in March. For both measures, the 12-month inflation rate moderated a bit, with that for headline CPI moving from 8.6% to 8.3% and that for core CPI moving from 6.4% to 6.2%.

“The core reading was higher than consensus expectations, while the headline reading was in line with expectations. After soaring in March, gasoline prices moderated a bit in April, and that accounted for the much lower headline reading. The core index excludes food and energy prices, so it was not affected by the -2.7% move in energy prices nor the +0.9% move in food prices.

“We have been looking for inflation to moderate as easing supply pipeline problems (and burgeoning inventories of merchandise) worked to slow goods price inflation. This process has actually been in place. As you can see in the accompanying chart, core goods prices have moderated substantially over the last three months. However, in true whack-a-mole fashion, the subsidence in goods price inflation has been accompanied—and in April, offset—by faster increases in services prices.

“It has been widely reported that housing costs have been rising and contributing to the faster services inflation. Also at work in April were a number of more esoteric factors. Besides housing, shelter costs were raised by a 2.0% increase in hotel/motel prices. Health care costs rose 0.5% in April, mostly driven by a 2.0% increase in health insurance costs. A 3.1% increase in public transportation prices accrued largely from a whopping 18.6% increase in air fares. Aside from these attention-grabbing price surges, increases in other service prices actually remained modest.

“The especially concerning aspect of most of these specific gains is that they are occurring in sectors still substantially under-utilized due to the lingering effects of the COVID-19 pandemic. Consumer spending on both hotels/motels and airfares are still about 20% lower than where a continuation of pre-COVID-19 trends would place them now, but prices there are jumping anyway.

“Of course, staffing in these sectors is even further below pre-COVID-19 trends, so it would seem that the price increases there reflect growing pains related to restaffing amid ongoing COVID-19 concerns. The question is how much US Federal Reserve policy will have to tighten to slow demand there, especially as recovery from COVID-19 pushes consumers back to utilizing these services. A better solution would be stronger employment growth and capacity recovery in these industries, and perhaps the slower wage growth reported in last week’s post will help in that regard.

“Meanwhile, of course, aside from these “special” factors, housing costs are moving higher steadily, and the Ukraine crisis and other factors are holding up food and energy prices. All in all, there does seem to be some progress in moderating overall inflation, but it is a bumpy and uneven process for sure.”

The post CPI inflation moderating only a bit in US appeared first on AdviserVoice.

Mr Kirkham notes in the podcast discussion: “We think the market has now factored in too many interest rate hikes and therefore we increased our duration overweight in late March and have continued to do so in April.

“We believe that once the market settles down, the credit spreads will be able to consolidate and ultimately tighten from here as the fundamentals return to being the main focus.

“We note that investment grade corporate space in Australia is a standout due to the type and quality of issuers in our market, all of which are generally able to pass on any inflationary pressure due to monopolistic duopolistic positions, not to mention the regulated assets that are also prevalent in our market, who can obviously just pass this on through their pricing resets.

“Supranationals, sovereign and agencies (SSAs) are also offering solid value, having seen their spreads widen due to excessive selling by Japanese insurers who saw their annuity products triggered due to the super high Aussie dollar versus a weakening yen. We will reallocate to these bonds once we believe the selling is done.

“We will keep our duration and curve positioning very active to capture the volatility in markets. We managed to capture the moves in the first quarter. Obviously, we’ll look to capture the expected volatility in markets in Q2 as well.”

———

[1] Please note that all performance figures discussed are net of fees and as of the 31st of March 2022, unless otherwise noted.
Western Asset is an active fixed income manager and part of the Franklin Templeton group.

The post Opportunities persist for Australian fixed income investors appeared first on AdviserVoice.