Key Takeaways
- The market narrative of “higher-for-longer” interest rates is supporting government bond yields, says Nedgroup’s Alex Ralph.
- She says the fund is staying away from debt issued by AI hyperscalers because of concerns over cash flow.
- There are plenty of “crowded trades” in government and corporate bond markets, she says.
Christian Mayes: Now, it’s been a turbulent year in the bond markets. Yields have risen across the globe as interest rate expectations shift, while central banks contend with rising inflation. In the corporate bond market, the AI hyperscalers continue to expand their presence.
To discuss what this means for investors, I’m joined by Alex Ralph, senior fixed income manager at Nedgroup Investments. Alex, thanks for coming in.
Why don’t we start with the central banks. The Fed’s just raised interest rates for the first time since 2023. I’d love to get your reaction to the decision and what it tells us about how central banks are thinking about inflation at the moment.
Alex Ralph: Well, I think because of the fairly strong economic growth that’s being sustained right now, they’ve pivoted toward what it means for the energy spike and what that means for mid- inflation expectations.
They’re fairly comfortable with raising rates right now with the backdrop. And I don’t think they want a repeat of the 2022 “too late to the game” to raise those interest rates.
But for us we think it’s a fairly different environment. A lot of the strong growth we’ve seen in recent months has been predicated on AI, particularly in the US.
If you look and drill down into that growth, half the US economy, for example, is suffering. So we think, actually, there’s too many hikes priced into the market right now.
But it’s interesting times because we’ll see if that feeds through into 2027 and if those growth numbers are actually sustained.
Why Are Bonds Selling Off?
CM: We’ve seen government bond markets sell off in recent months. Could you explain why that’s happening? And given you run a global portfolio, you have the ability to invest anywhere: What do higher yields mean for how the opportunity set is shifting in fixed income?
AR: It’s an incredibly interesting time within government bond markets. If we actually drill down into what’s moving their yields higher, inflation expectations actually haven’t really changed. They’ve stayed, in the long term, fairly anchored.
So what has changed is that structural expectation of “higher for longer” on those interest rates.
There are some arguments that maybe the AI buildout and the issuance from hyperscalers is also crowding out a bit of government debt and creating that increase. But we think it’s mainly to do with that higher-for-longer narrative.
But also it’s really interesting from a global fund manager point of view. It’s great, because in the G7 there are so many different dynamics driving growth that we think interest rate profiles will be quite different over the next 12 months.
So we’re able to play that expectation and that change, and being able to do that fairly nimbly means it gives us a great opportunity.
How to Trade the Yield Curve
CM: You touched on the competition for capital between the hyperscalers and government bonds, particularly at the longer end of the market. What are your thoughts on duration at the moment and of that competition between the two?
AR: Well, it’s interesting again, because actually we feel that there’s a lot of crowded trades going on.
For example, on our fund going into August, we actually had flatteners on. We were invested in the long end, particularly in Europe and Japan. We felt that the curve was too steep and that everyone was crowded in the same trade.
And that really worked for us as the curve flattened in August and the beginning of September because people were positioned. But now, as I say, we think too many interest rate hikes are priced into the curve, especially within Europe. We have moved to steepeners.
So that flexibility and how much the curve is moving in a quite volatile manner, again, provides this opportunity for active fund managers to take advantage of that.
Why this Manager Is Shunning AI Debt
CM: In terms of the corporate bond portion of your portfolio, how are you viewing the debt from the hyperscalers and what are the risks and rewards on offer?
From a credit perspective, for us it’s all about certainty of cash flow or the belief in that cash flow. While we actually stayed away from hyperscalers at the start of the year, purely because of the extent of issuance, and every month they increase that issuance as well, there was, by the middle of the year, a little bit of opportunity to take positions in more of the stronger balance sheets such as Amazon.com and Google, just because we thought there was short-term value there.
But overall, from a credit point of view, we are staying away from AI in general, the data centers and any other part of that circular financing. We’re not comfortable that actually the cash flow will be produced in the end. From a balance sheet point of view, we’d rather stick with the much stronger, secure companies because we don’t think the cash flows will be there in the end.
Opportunities Within Corporate Bonds
CM: Interesting. So where do you like in the corporate bond space?
AR: For us, it’s been an interesting market in terms of the fact that the overall market has stayed expensive and incredibly unvolatile. While there’s been very little movement even in the last two or three weeks with the government bond selloff, credit has moved a tiny bit wider in Europe, but not much.
But if you drill down under that, there is quite a bit of movement, thanks to the hyperscalers, thanks to various situations locally such as French financials have really underperformed due to the backdrop fiscally in France.
So it’s been more that what you don’t own has made you perform. However, there have been individual opportunities to be able to play some spread compression, particularly in the new issue markets. So we have made decent returns from companies such as Heathrow and AA, where there’s been a little bit of volatility on the back of the Iran war.
So there has been opportunities on a stock selection basis. Despite a serene credit market overall, we have been able to take advantage of that market dislocation that’s starting to come underneath the bonnet.
Active Managers Navigate Volatility
CM: Do you have any final takeaways for investors on navigating higher yields at the moment?
AR: The main two points is the volatility for active managers makes it very exciting times for us to be able to outperform. But also for us, we’ve got to keep a real eye on liquidity.
Because as I said, there are crowded trades within the curve on the government bond market. But there are also crowded trades within credit, particularly in short-duration credit.
We are very mindful of liquidity, especially as credit spreads are so expensive. that we want to be in the most liquid parts of the market.
And obviously, taking into account the increased risks with the AI buildout but also the private credit situation. So liquidity is very important for us.
CM: Thanks for coming in, Alex. For Morningstar, I’m Christian Mayes.
