Talking with Fabio Angelini, from Nordea AM, on European Bonds
21 MAY, 2024
The bond market has been affected by enormous market volatility in recent years. Volatility generated by the macroeconomic environment, changes in interest rate expectations and geopolitical conflicts have increased the importance of analysing and selecting fixed income assets for portfolio construction. Fabio Angelini, Senior Investment Specialist of European Fixed Income at Nordea AM, shares his views on the fixed income market in this interview with RankiaPro.
How has the bond landscape changed in 2024 compared to 2023?
In most of 2023, the market expected a high for longer rates scenario, patiently waiting for inflation to wane on the back of the restrictive monetary policy the ECB put in place. In reality, progress on inflation materialized quick enough to propel some relatively euphoric optimism towards the end of 2023 that the ECB would cut sooner than later.
So far in 2024, optimism left ground to a more timid (but also more realistic) expectation of a modest rate cut in the second part of 2024, and more cuts in 2025. Importantly enough, caution was spurred by more stubborn inflation in the US among other things, even if inflation in Europe keeps printing lower and not really far from ECB target.
Both in 2023 and 2024 so far, credit has been the strongest performing asset class with duration still lagging and waiting for the ECB to pull the trigger on rates cuts.
How can investors navigate the bond market now that rates appear to be about to fall?
Intuitively, elevated yield levels ahead of a likely cutting cycle with somewhat realistic expectations of the next ECB monetary policy moves provide for a strong backdrop for most fixed income asset classes.
Volatility however is still high and it is not really clear if Europe can avoid a recession by the time ECB actually cuts interest rates.
Bringing these two considerations together, it remains important to diversify across the broader fixed income spectrum, looking for answers to questions like “where can duration be found at a good price today?” “what companies are able to withstand an elevated cost of debt environment?”
Being selective in each asset class will likely make the difference, especially because dispersion within and across sectors is still high.
Liquidity in the bond market has been a much-discussed topic in recent years. What do you think in the role of liquidity at this time?
As every price in the world is eventually set by the balance of demand and supply, liquidity keeps playing an important role. From a monetary policy perspective, the ECB tightening is reducing overall liquidity in line with quantitative tightening targets. This generally means that it is becoming more and more challenging for companies to source funding and liquidity as the ECB pulls back from its role of large buyer of bonds in the market seen in the last many years before the 2022 inflation spike.
Importantly enough however, it is worth noticing that over the last couple of years a large amount of liquidity stack up in the form of bank deposit, as banks offered an increasingly high deposit rate to customers along rate hikes. These deposits are approaching maturity and investors will be called to decide whether renewing the deposit at a lower rate into a rates cutting cycle or invest the liquidity in the market at higher rates. This will realistically provide for at least some liquidity re-entering the bond market, and could partially counterbalance the ECB tightening action in the near future.
To what extend do you think geopolitical tensions will affect the bond market?
Geopolitical tension generally affect all financial markets, often in significant ways. This will likely remains key source of volatility in 2024.
Market volatility is a constant. Which risk management strategies do you consider most effective in the current context of the European bond market?
Among others, a bottom-up approach to selecting credits can likely serve well investors concerned that companies would struggle to cope with the increasing cost of debt due to high interest rate environment.
The search for relative value is also a potent approach to counterbalance market uncertainty with a more tactical approach. As an example, financial issuers are currently trading at wider levels compared to many other sectors and yet boast particularly strong fundamentals, not least due to their fitness to a high interest rate environment like the present one.
Which sectors of the bond market do you consider most interesting right now?
As mentioned before, an interesting sector at this stage could be the banking space. Banks have generally profited from rising interest rates, and were able to post extraordinary earnings while still provisioning for bad times ahead. This setup is unparalleled when compared to virtually any other sector, whereby non-financial companies were instead fighting hard with inflation, looking to transfer higher prices to end customers to make up for higher prices paid to suppliers. Despite strong fundamental health, the European banking industry offers yield levels generally more elevated than non-financial credits, which can be seen as an interesting opportunity.
Insurance companies also look attractive in this sense, as they are on average entities even better capitalized than banks, often more profitable and yet trading at similar yield levels.
Financial debt is however a particularly complex sector, and one where bond instruments play a major role in price developments. While we would argue that some more caution is due on AT1 and CoCos for example, subordinated tier 2 bonds appear instead more attractive.
