The monetary policy debate is likely to continue to dominate volatility in government bonds markets, and its ripples are likely to impact broader fixed income markets.
The Federal Reserve will now likely hike rates one more time this year, having capitalised on somewhat over exuberant growth expectations to push short-term rates higher.
Longer-term expectations have been tempered by a lack of fiscal and regulatory reform in the US, and as a consequence we continue to believe any increase in rate expectations is likely to be accompanied by a flatter yield curve.
In contrast, inflation in Europe is forecast to pick up in the short term, and a move off a distressingly low level. With virtually no carry to provide any protection, we would avoid EU government bonds and anticipate a steeper curve.
Investment grade spreads remain attractive on a relative basis to government bonds.
Corporate bonds should provide a steady pick up on governments and with a positive economic backdrop, spreads are unlikely to materially widen despite the trajectory of Fed and European Central Bank policy.
We would, however, continue to avoid UK domestic names, where the slower pace of growth presents a headwind.
Investment grade emerging markets look set for continued recovery following a period of declining growth, and tighter financial conditions and IG hard currency debt continues to offer opportunity.
Being selective from a country perspective is warranted in both local and US dollar markets, and there are some countries where monetary policy is turning to favour lower yields, as depreciation-driven inflation subsides and central banks can cut rates.
Brazil and Mexico stand out as notable names here. Currency volatility remains a core driver of returns in the local space and as a consequence our preference remains hard currency debt on a broad basis.
We struggle to see value in being overweight high yield, and we would avoid sectors in the midst of structural change, such as retail and energy, and take a cautious stance on more cyclically-exposed sectors, such as auto-parts.
Michael Leithead is manager of the New Capital Wealthy Nations Bond and the New Capital Global Value Credit funds
• Low quality investment grade corporate bonds vs high yield
• Improved growth in emerging markets - particularly Brazil and Mexico
• Pick-up in inflationary expectations means European government bonds look unattractive
• UK corporate bonds could be impacted by slower growth expectations