{"id":384405,"date":"2024-08-16T10:30:29","date_gmt":"2024-08-16T14:30:29","guid":{"rendered":"https:\/\/qa.bluevaultpartners.com\/?p=384405"},"modified":"2024-09-03T11:19:23","modified_gmt":"2024-09-03T15:19:23","slug":"the-dividends-of-policy-divergence","status":"publish","type":"post","link":"https:\/\/qa.bluevaultpartners.com\/the-dividends-of-policy-divergence\/","title":{"rendered":"The dividends of policy divergence"},"content":{"rendered":"

Christopher M. Chapman, CFA<\/a> | John Hancock\u00a0<\/a><\/em><\/p>\n

Key takeaways<\/h4>\n
\n
\n

\u2022 \u00a0Interest-rate policy divergence continues to be a source of duration opportunity for actively managed fixed-income investors.<\/p>\n

\u2022 \u00a0We think attractive credit opportunities are still possible to find, especially when investors adopt a research-based approach.<\/p>\n

\u2022 \u00a0The U.S. dollar will likely continue to be the reserve currency of choice for years to come, despite the so-called trend of de-dollarization.<\/p>\n

Active duration management matters once again<\/h4>\n

From the vantage point of August 2024, the inflation pressures of recent years have declined substantially. Central banks, after their period of tighter policy, pivoted to a wait-and-see mode\u2014and now are pivoting once again as they\u2019ve begun to drive policy rates lower.<\/p><\/div>\n

\u00a0<\/div>\n
As of this writing, we\u2019ve seen rate cuts from the Bank of Canada, the European Central Bank, and the Bank of England, among others. And we expect additional developed-market central banks, notably the U.S. Federal Reserve, to join in cutting rates over the coming months and into 2025.<\/div>\n
\u00a0<\/div>\n
This has validated our favorable view of interest-rate risk coming into the year, and we maintain this view. We see the current fixed-income landscape as having downward momentum in global yields, but we don\u2019t see yields falling uniformly. Indeed, we expect to see rates fall at different paces, along with occasional volatility and checkbacks\u2014temporary reversals or retracements of falling rates. This divergence in the timing and magnitude of rate changes, we think, will translate into opportunity for an active approach to global fixed income.<\/div>\n<\/div>\n

In other words, we can express our favorable view on interest-rate risk by actively managing portfolio duration, tactically embracing divergences in policy when and where we have conviction.<\/p>\n

Looking beyond yield for better credits<\/h4>\n

The policy-driven duration opportunities we see are just a part of the story underscoring the merits of a global fixed-income approach. An additional part, among others, is the active role of asset allocation in managing credit risk.<\/p>\n

At the moment, conditions in global fixed income are much more favorable from the perspective of income generation than they were in recent years. Gone are the days of zero cash rates and negative-yielding fixed-income instruments. But that doesn\u2019t mean risk is no longer a real concern; on the contrary, we believe it\u2019s beginning to matter more where investors are finding sources of yield.<\/p>\n

Now more than at any point so far in the present economic cycle, we believe investors must be thoughtful about where yield is sourced\u2014particularly in riskier segments of corporate credit, such as U.S. high yield. While we believe there are attractive opportunities here, valuations warrant being more thoughtful: Beyond yield, what’s a debt holder getting in terms of issuer quality, security covenants, and sector strength?<\/p>\n

\n
High-yield spreads have recently been at historically tight levels<\/strong><\/div>\n
\u00a0<\/div>\n
ICE BofA US HY Index vs. U.S. Treasuries, option-adjusted spreads, 2\/22\/11\u20136\/30\/24<\/div>\n

\"TheSource: The Intercontinental Exchange (ICE) Bank of America (BofA) U.S. High Yield Index tracks the performance of below-investment-grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market and includes issues with a credit rating of BBB or below. It is not possible to invest directly in an index.<\/span><\/p>\n<\/div>\n

As of late July, the spread between the ICE BofA U.S. High Yield Index versus 10-year U.S. Treasuries was approximately 300 basis points (bps). Over the last 20 years, that spread has averaged closer to 500bps. Put another way, spreads have been wider than they are now roughly 90% of the time over the past two decades, which indicates the relative expensiveness of U.S. high-yield bonds today.<\/p>\n

This is another reason why we believe being an active investor now is so critical. In addition to being able to take advantage of policy rate divergence, an active approach to asset allocation and credit selection can help investors avoid the minefield of spread widening. In other words, a risk-aware fundamental approach may help global bond investors continue to enjoy the benefits of diversification without incurring an inordinate amount of pain from bond market volatility.<\/p>\n

No regime change when it comes to reserve currencies<\/h4>\n

In recent quarters, investors may have seen headlines<\/a> around governments wishing to move away from the U.S. dollar as the reserve currency of choice. This has occasionally prompted questions about the potential role currency risk<\/a> plays within a global bond allocation. This perennial topic has reemerged in the context of so-called de-dollarization, which is a variably supported trend of certain governments expressing a desire to participate in global trade in their own currencies.<\/p>\n

\n
While nontraditional currencies are playing moderately larger FX roles, the U.S. dollar maintains its dominant status<\/strong><\/div>\n

Currency composition of global foreign exchange (FX) reserves, 2016\u20132024 Q1 (%)<\/p>\n

\"TheSource: International Monetary Fund, March 31, 2024.<\/span><\/p>\n<\/div>\n

De-dollarization is, in fact, happening, but it\u2019s in no way a near-term threat to the U.S. dollar\u2019s status as a reserve currency. Consider, for example, the composition of central bank reserves, which the International Monetary Fund (IMF) tracks through its composition of official foreign exchange reserves. As the IMF’s data shows<\/a>, the U.S. dollar was a little bit over 70% of the total weight of those reserves in 1999; more recently\u2014from 2021 through the first quarter of 2024\u2014that weight had declined to slightly below 60%. But then consider the next largest currency within that balance: the euro at 21%. At that level, we can easily see that the U.S. dollar still has a healthy lead over other currencies.<\/p>\n

When we look at where reserves have moved, we find they\u2019ve been spread across a variety of different currencies. Some of the balance has gone to the dollar bloc\u2014including the Australian dollar, the New Zealand dollar, and the Canadian dollar\u2014and some has gone to Asian currencies, such as the Korean won and the Singapore dollar and, of course, to the Chinese renminbi.<\/p>\n

\n

When politically charged thinking gets involved in the question of the U.S. reserve currency status, people point to the Chinese renminbi. And it has risen\u2014from about zero to about 2.5% to 3%. So, again, there’s still an enormous difference between the U.S. dollar and the renminbi.<\/p>\n

Furthermore, from a daily liquidity perspective, we can consider the triennial survey of daily liquidity volume in the foreign exchange market. According to the most recent survey from the Bank of International Settlements (released in 2022), over the last 20 years that market has grown from about a little over US$1 trillion traded daily to approximately\u00a0$7.5 trillion<\/a> (in aggregate U.S. dollar terms). Considering every currency trade involves two currencies, the U.S. dollar portion of that daily volume figure has gone from about 90% down to about 88%. There has been a slight reduction, but the U.S. dollar remains far and away the largest component of daily foreign exchange volume.<\/p>\n

Ultimately, these changes in reserve and liquidity levels haven’t materially affected how we approach currency exposures. The history of currency reserves shows that balances have always been evolving, but we believe the degree of change is better measured in generations rather than years.<\/p>\n

\u00a0<\/div>\n

Important disclosures<\/span><\/strong><\/span><\/p>\n

Views are those of the authors and are subject to change. No forecasts are guaranteed. This commentary is provided for informational purposes only and is not an endorsement of any security, mutual fund, sector, or index, and is not indicative of any John Hancock fund. Diversification does not guarantee a profit\u00a0 or eliminate the risk of a loss. Past performance does not guarantee future results<\/span>.<\/p>\n

Duration measures the sensitivity of the price of bonds to a change in interest rates.<\/span><\/p>\n

Credit rating refers to the credit score rating agencies assign to a debt issuer that reflects the debt issuer’s creditworthiness. It is widely used as an estimate of the level of risk involved in extending loans to entities, including businesses and governments.<\/span><\/p>\n

One hundred basis points equals one percent.<\/span><\/p>\n

Individual bonds are rated by the creditworthiness of their issuers; these ratings do not apply to the fund or its shares. U.S. government and agency obligations are backed by the full faith and credit of the U.S. government. All other bonds are rated on a scale from AAA (extremely strong financial security characteristics) down to CCC and below (having a very high degree of speculative characteristics).<\/span><\/p>\n

Fixed-income investments are subject to interest-rate and credit risk; their value will normally decline as interest rates rise or if an issuer is unable or unwilling to make principal or interest payments. Investments in higher-yielding, lower-rated securities include a higher risk of default. Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability. Currency transactions are affected by fluctuations in exchange rates. Liquidity\u2014the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all\u2014may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. The use of hedging and derivatives could produce disproportionate gains or losses and may increase costs. Fund distributions generally depend on income from underlying investments and may vary or cease altogether in the future. Please see the fund\u2019s prospectus for additional risks.<\/em><\/span><\/p>\n

MF3791515<\/span><\/p>\n<\/div>\n

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The global interest-rate easing cycle is under way. We explore what that means for investors taking a global view on fixed-income opportunities while putting credit and currency risk in perspective.<\/p>\n","protected":false},"author":3870,"featured_media":384406,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3009,2946,2952,2953,2955,2958,3838],"tags":[],"class_list":["post-384405","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-asset-manager-perspectives","category-economy","category-global","category-government","category-inflation","category-interest-rates","category-john-hancock"],"acf":[],"yoast_head":"\nThe dividends of policy divergence - Blue Vault<\/title>\n<meta name=\"description\" content=\"The global interest-rate easing cycle is under way. 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