Fixed Income Third Quarter Outlook

PGIM Fixed Income shares their views on the current economic environment and outlook for fixed income markets.

July 12, 2019

Each quarter, PGIM Fixed Income publishes an outlook describing their views on the economy, as well as their expectations for sectors within the bond markets. Here’s where they see value (and where they don’t) in the coming quarter.

While record highs on the major equity indices make for good headlines, the year-to-date returns posted by several fixed income sectors are impressive in their own right. Fueled by the second quarter’s collapse in developed market rates, long U.S. corporates (+15.77%), emerging market hard currency debt (+11.31%), long U.S. Treasuries (+10.98%), and U.S. high yield (10.16%) are among the sectors with double-digit returns thus far in 2019. But with many rate complexes at multi-year lows, what should investors anticipate from fixed income going forward?

At a glance - PGIM Fixed Income sector views as of as of July 2019

Sector

Outlook

Rationale

Developed Market Rates

Tactical

Tactical. Although rate complexes across the G4 collapsed in Q2, the move lower was justified by further moderation in global economic conditions. Therefore, we expect low and rangebound rates in Europe and Japan. U.S. Treasuries—particularly real rates—may see additional support until a catalyst potentially contributes to a short-term correction.

Agency MBS

Positive

Positive vs. developed market rates. Nominal and option-adjusted MBS spreads remain at multi-year wides and lagged tightening in other high-quality sectors. Given the decline in primary rates, it may take longer than usual for seasonal supply to stabilize. If the Fed cuts rates, we could see banks increase MBS holdings. We continue to prefer specified pools and to avoid TBA exposure. We favor modest up-in-coupon exposure away from 30-year 3%. We expect to add higher 30-year UMBS coupon exposure later in Q3.

Structured Products

Positive but selective

Positive. We remain biased toward top of the capital structure, which offers high risk-adjusted spreads for fundamentally remote credit risk. We generally remain negative on mezzanine structured products and remain mindful that Q3 has historically had meaningful bouts of volatility. Thus, Q2’s intra-quarter volatility reaffirms our top-of-the-capital-structure bias amid the ageing credit cycle, slightly deteriorating collateral quality, and flat securitized credit curve.

IG Corporate Debt

Positive

Positive in the near term given favorable fundamentals, healthy technicals, and potential for tighter spreads. We still favor U.S. money center banks. U.S. tax reform remains supportive.

Global Leveraged Finance

Constructive

Constructive on U.S. high yield, particularly in the belly of the curve, with a preference for Single Bs. We favor the higher-rated portion of the U.S. leveraged loan market. In Europe, we prefer high yield to bank loans.

Emerging Market Debt

Conditionally Constructive

Conditionally constructive for spreads, select local bonds, and EMFX—assuming a reasonable outcome to trade negotiations and clearer evidence of growth in China. With the caveat that a supportive backdrop could fail to materialize, there is scope for attractive spread tightening in investment grade and high yield countries and corporates. The outlook for EMFX and rates is less clear, but attractive relative value opportunities remain.

Municipal Bonds

Moderately Positive

Moderately positive. Strong technical framework and fair valuations should lead to outperformance vs Treasuries.

 

The full PGIM Fixed Income Market Outlook PDF opens in a new window  is available for financial professionals.



Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security backed by commercial mortgages rather than residential mortgages. They are composed of a variety of loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. High yield bonds, known as junk bonds, are subject to a high level of credit and market risk. International bonds are bonds issued by foreign corporations or foreign government agencies. Emerging market bonds are local currency bonds issued by emerging market governments. Emerging market countries may have unstable governments and/or economies that are subject to sudden changes. These changes may be magnified by the countries’ emergent financial markets, resulting in significant volatility to investments in these countries. Investment-grade corporate bonds are bonds with a credit rating of AAA to BBB as rated by Standard & Poor’s, or Aaa to Baa as rated by Moody’s. Mortgages refer to mortgage-backed securities (MBS), which are composed of a variety of residential mortgage loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. Collateralized loan obligations (CLOs) are securities backed by a pool of debt, often low-rated corporate loans. Municipal bonds are tax-exempt bonds with a maturity of at least one year, including state and local general obligation, revenue, insured, and pre-refunded bonds. Unlike other investment vehicles, U.S. government securities and U.S. Treasury bills are backed by the full faith and credit of the U.S. government, are less volatile than equity investments, and provide a guaranteed return of principal at maturity. Asset allocation and diversification do not assure a profit or protect against loss in declining markets. Past performance is no guarantee of future results.

The views expressed herein are those of PGIM Fixed Income investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither Prudential Financial, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.

This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. Clients seeking information regarding their particular investment needs should contact a financial professional.

PGIM Fixed Income is a unit of PGIM, Inc. (PGIM), a registered investment advisor. PGIM is a Prudential Financial company. © 2019 Prudential Financial, Inc. and its related entities. PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.

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Mutual fund investing involves risk. Some mutual funds have more risk than others. The investment return and principal value will fluctuate and investor's shares when sold may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Asset allocation and diversification do not assure a profit or protect against loss in declining markets. There is no guarantee a Fund's objectives will be achieved. The risks associated with each fund are explained more fully in each fund's respective prospectus. Consult with your attorney, accountant, and/or tax professional for advice concerning your particular situation.

This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. Clients seeking information regarding their particular investment needs should contact a financial professional.

Investment products are distributed by Prudential Investment Management Services LLC, a Prudential Financial company, member SIPC. Separately Managed Accounts are offered through our affiliates. Jennison Associates and PGIM, Inc. (PGIM) are registered investment advisors and Prudential Financial companies. QMA is the primary business name of QMA LLC, a wholly owned subsidiary of PGIM. PGIM Fixed Income and PGIM Real Estate are units of PGIM. © 2019 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, PGIM Real Estate, PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.

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