Fixed Income Conversation Corner with Ed Al-Hussainy (Columbia Threadneedle) and Leslie Falconio (UBS CIO)
The desk posits that the current fixed income landscape, as discussed by analysts Ed Al-Hussainy from Columbia Threadneedle and Leslie Falconio from UBS, reflects a cautious optimism driven by improving growth prospects and the potential for further monetary policy adjustments. Per the full note source, the shift in investor sentiment has led to compression in credit spreads and a stronger dollar, despite concerns over US trade policy uncertainty. Key recent data suggests that treasury yields have increased, indicating market expectations of sustained economic growth. As markets digest these insights, they must also remain alert to upcoming developments in monetary policy and economic indicators.
What the desk is arguing
The prevailing sentiment among fixed income investors is one of cautious optimism, supported by recent growth signals despite trade policy uncertainties. Analysts at UBS and Columbia Threadneedle highlight a notable rally in equities and treasury yields, reinforcing the expectation of continued economic recovery as evident from tighter credit spreads.
Additionally, the shift in positioning across assets echoes a broader market tendency to price-in optimism for growth, driven by strong fundamentals observed in early 2023. Ed Al-Hussainy's commentary underscores this resurgence in investor confidence, particularly in the wake of previous downturns.
Where it sits in our coverage
Current consensus targets suggest a range for the USD/EUR pair around 1.075, with specific firm forecasts indicating: - jpmorgan: 1.10 (Mar-26) - bofa: 1.04 (Mar-26)
UBS's outlook reflects a firm stance within the mid to upper part of the spectrum, asserting confidence in economic momentum, while bofa represents a more cautious perspective at the lower end of the target range.
How other firms see it
Many firms align their forecasts with the desk's cautious bullish outlook, mirroring sentiments from jpmorgan. On the contrary, bofa has taken a more conservative approach, suggesting lower growth expectations.
Watch for the USD/EUR trajectory to be influenced by movements in treasury yields and overall monetary policy guidance from the Fed, as these factors could rapidly reshape market sentiment.
01Cautious optimism dominates the fixed income landscape as economic recovery signals strengthen.
02Significant credit spread compression has occurred, suggesting improved risk appetite among investors.
03Upcoming monetary policy guidance from the Fed is critical for sustaining the current growth narrative.
04Concerns remain over US trade policy which could affect market dynamics and investor sentiment.
Market implications
Traders should monitor treasury yield movements closely, particularly as yields above 3.5% could signal a shift in risk sentiment. The upcoming Federal Reserve announcements will be pivotal in determining whether the current optimism can be maintained in the face of trade uncertainties.
Risks to this view
A shift in monetary policy that signals a tighter stance than anticipated could lead to a rapid reassessment of risk across fixed income markets. Additionally, unexpected trade policy outcomes may adversely affect market perceptions of economic growth.
ubs
Hi, everyone. Dan Cassidy here. Welcome back to the Fixed Income Conversation Corner podcast series right here on the UBS Market Moves podcast channel.
Joining us for the conversation today, glad to welcome back Leslie Falconeo, head of taxable fixed income strategy for the Americas with the UBS Chief Investment Office. We're glad to welcome as well our guest from Columbia Threadneedle Investments, Ed Al-Husseini, joining me right here in studio in 1285 here in New York. Ed serves as global interest rate strategist for the firm.
So with that, Leslie and Ed, very timely that you're joining us, a lot to talk about given recent market conditions. So with that, Leslie, I'll pass it over to you to lead today's conversation with Ed. Great.
Thank you so much, Dan. Ed and I have shared a panel together on Bloomberg, and I think that today's conversation is not only timely, but it's going to be actually very important in terms of how we're looking at the rest of the year, and I appreciate you coming on and sharing your expertise. I know that your thoughts and opinions are very meaningful to both our clients and advisors.
So thanks so much for hopping on this podcast. I really appreciate it. Thanks for having me on.
So I want to start off, before we get into the liberation and post events, I just want to get your take on prior to that time frame, right? How were you sort of looking at the first quarter in terms of asset class performance versus some of your expectations, I mean, prior to some of the announcements that we heard last week? Yeah, absolutely.
I think if we go back to the last quarter of last year, I think what was extraordinary was the amount of optimism about growth that got priced into assets across the board. We had a pretty significant compression in credit spreads. We had a rally in the dollar.
We had a rally in equities, and treasury yields moved higher, all consistent with growth expectations for this year, essentially being nailed to the ceiling, and it was going to be really difficult to satisfy those expectations. And so the first three months of this year, even ahead of the tariff announcement, I think we spent moderating those expectations. A lot of, I think, expectations from households and companies became softer in what we call the soft data and survey-based metrics in terms of the outlook for the year.
And so treasury yields rallied. We had some weakness in equities, and we had some decompression in credit spreads, and that was all very consistent with a little bit of that growth premium coming out of assets ahead of this week. So when we think about, and again, I mean, you know, actually our expectation was heading into the year, you know, the tariffs in and of itself were just not necessarily obviously a surprise post-election.
You don't know the sequencing. We didn't know the depth, but our expectation overall prior to last week was that we'd have this slow growth come into the marketplace, this inflation trend would continue, not necessarily a straight line, and we would not assume, we didn't assume that we'd have a lot of credit spread compression, and most of our total return would be via the carry component in terms of fixed income assets. But as we see sort of this announcement yesterday and the magnitude of the moves that we've seen, like, how do you think this is going to impact sort of the fixed income markets, not just today, but over the next several months?
Yeah, it definitely adds an element of risk for credit spreads. And so to the extent that I think people were conservative with risk getting into this week, to the extent that we see some decompression in spreads, I think, one, it's an opportunity to be adding to risk if you relied on risk at the beginning of the year. But two, you've got to be really careful.
The probability that the economy ends up in a bad place has definitely gone up. The policy mix is, if anything, more uncertain after this week. And so you've got to be careful.
I think our strategy here has been, we were long duration at the beginning of the year, we've been opportunistically taking that down, so reducing, taking profits on some of those treasury trades, and opportunistically adding to credit. Because in an environment where you find it's essentially a buyer's market like we've had this week, that's really an opportunity to add a little bit of credit. You want to do it carefully.
You don't want to be all in at this stage. But it's definitely a better market than we've had over the course of the last couple of months. When we think about that in terms of how you want to do this, so you're saying that what you would do in terms of your fixed income positioning is that you came in fairly conservative, had a bit of duration risk, you've taken that down, and you've shifted more to taking out a little bit more credit risk, I'm sure, opportunistically.
I think it's safe to say you're not full boat. It's just these kind of small ads as things get wider, or how would you sort of phrase that? I think that's exactly right.
It's small bites in terms of places where we see babies getting tossed out with the bathwater essentially. I think the broad underlying story in corporate credit is still quite good. Corporate balance sheets are in excellent health going into the shock, so we expect companies to be able to weather this relatively well.
But given the uncertainty in the risk environment, we're seeing this spread decompression or spread widening. That's really when you want to be adding to risk, and that's what we've been doing in the margin. Let's shift to monetary policy for a second.
We know that the market was pricing in, it's not today given the recovery that we've seen, but it was pricing in close to five cuts in the silver futures, and we know that the fixed income market, it's not the first time it's Craig Wolf, it's not the first time that it's gotten a little overzealous in terms of price cuts or rising recession probabilities, although this time may be different, quotes, because of the implications of these potential tariffs. But when you think about monetary policy over the next year, how do you see this playing out, number one? And number two, are you concerned that the market's reaction is going to be similar to what it was in September, as you have this growth inflation push me, pull me, and they actually cut and interest rates rise?
Yeah, that's a really good question. I think we've gotten very aggressive in terms of expectations for Fed cuts this year. My sense in the early messaging from the Fed, we had some language from Powell at the end of last week, some other Fed speakers so far this week, all pretty consistent with putting a lot of weight on the upside inflation risks relative to downside risks to growth and employment at this stage, which basically means the Fed is quite comfortable delaying whatever they're going to do into the back end of the year at this stage.
My bet is when financial conditions tighten, when we have a pretty significant de-risking in credit markets and equity markets, that is going to overwhelm the Fed's fear around upside risks to inflation. We're nowhere near that stage right now, but I think that is something that's in the background. So what that means for the strategy is it makes sense to wait.
It makes sense to be more aggressive, but do it later. And market pricing right now is too front loaded versus that strategy, and so I think right now, front end yields, if anything, are biased a little bit higher, but longer end yields are much better value at this stage, 10-year yields around, let's call it 4.25. The second part of your question is really kind of critical.
We have a pretty different fiscal outlook, not just in the U.S., but globally. We've had a sea change in core Europe, in Germany with the constitutional reforms, additional borrowing coming online there. We have additional pressure on governments around the world to compensate from growth losses related to trade by expanding fiscal spending, by compensating the losers, adding a little bit of demand incrementally.
That's particularly true in China, which is dealing with a deflationary problem. So we may end up with an environment later this year where there's almost a correlated increase in fiscal deficits, not just in the U.S., but in Europe and China and across the emerging market world. That's an environment that can be quite dangerous for duration risk.
The push and pull between recession risks rising as demand slows here in the U.S. and trade-exposed economies versus the upside push on rates because the fiscal outlook has deteriorated. In general, I think the recession risks will win out, but it is very unusual for us to be concerned about a fiscal outlook in an environment where the economy is slowing and where we have this quite growth-negative policy mix on the horizon. I think you bet those are great points, and I think why this is so important to all of you, and I know that that correlation of equity and fixed income is such a big driver in terms of the term premium that gets embedded into the marketplace or how much investors should be compensated for locking up their money, say, for 10 years.
So when you think about that today and just how people look at it at 60-40 and going forward, given where we've seen spreads or given the fact that cash could be something they could do off of, how do you see what people will put to work in terms of either cash or fixed income overall, given the fact that that's not necessarily a 2022 environment, but the potential of the correlations between equity and fixed income not moving in exactly the trend that one might anticipate? I mean, that's such a core question in portfolio construction. The good news is if we look at the last 18 months, when we've had significant drawdowns in equities, treasuries performed as expected.
That was true around the Silicon Valley bank shock. It was true at the end of the summer when we were becoming concerned about the labor market slowing, and it was true again in the course of the last couple of months. For an investor exposed to treasuries and an investor owning treasuries as a buffer against equity risk, those have been really important demonstration moments that we are, in fact, in a different regime versus, let's say, 2022 or even 2018 when there was much more inflation in the system and it was skewed to the upside.
So I think we're starting from a much better place. The Fed's done a really good job of squeezing that inflation risk out of the system. Inflation-adjusted yields are higher, right?
Think about roughly 2% on a 10-year TIPS bond. So we have a much better shot at treasuries playing that buffer role against equities in the future, and that's great for a 60-40 portfolio. That's great for anyone constructing a diversified portfolio of equities and bonds.
The second point I'll make is, and this is especially true, again, over the last six months or so when the Fed started its easing cycle, its cutting cycle, duration is going to outperform cash in most environments where we have risk off and where we're starting to become concerned about recession risk. Again, on display over the course of the last three to four weeks, duration has done significantly better than cash. I think we can have a conversation about, like, where do you want to be on the curve?
Do you want to be really far out? I think you and I both prefer the belly, that intermediate part of the treasury curve, but it's definitely better than being exposed to cash in this environment. Yeah, we couldn't agree more, and you're right.
We do prefer that sort of belly, intermediate part of the curve. It's actually, you know, it's probably been one of the leaders in outperformance these past several months. Let's talk about sort of pockets of vulnerability parlaying to moments of opportunity, right?
Volatility, that's a good thing about volatility, it increases the opportunity set from levels that were very, very tight. Where do you see pockets of vulnerability, right? And where do you see this leading to opportunity within any asset class?
If it's the US, the M, whether it's munis or high yield, how are you sort of seeing this across, you know, fixed income right now, either global or domestic? Yeah, I mean, the opportunity set really, to me, is in corporate credit right now, you know, particularly in US high yield corporate credit, that single B space, to the extent that we see spread decompression, that's where we'd be incrementally adding risk, triple B in IG, single B in high yield. Again, the underlying story there is balance sheets going into this environment in considerably better shape, you know, when you look at balance sheet metrics like coverage and leverage, basically your ability to service debt, your ability to protect yourself from default risk, much better than at any point in the last decade.
And so anytime those assets go on sale, we're going to be there to pick them up. I think in emerging markets, I think the opportunity set is a lot narrower. Right now, they've outperformed, they've done really well in the course of the last several years.
Considering there's been very limited flow into that asset class, spreads have kept up with US credit, they've kept up with European credit, so we're really looking at the stress names there as being somewhat vulnerable to a pullback. EM has been unusual in that it's gone through a default cycle that's been more aggressive and earlier relative to developed market credit, and we've harvested a lot of that premium, a lot of that premiums come out of spreads. So now I think they're a little bit more vulnerable.
The second thing is on the dollar, we're in this unusual environment where the dollar has become highly correlated to equities, to US equities. And so at the end of last year, we had a dollar rally coinciding with US equities rallying. So far this year, the dollar has weakened alongside US equities.
It's put a lot of pressure on, I think, US-based investors to diversify into equities abroad. That's been kind of the core thematic, I think, in equities has been a move out of the US and into the rest of the world. That trade is very vulnerable to an environment in which the kind of the safe haven bid returns for the dollar.
In other words, the dollar starts to rally because recession risk in the US is rising. So I think the biggest vulnerability is that trade being short-circuited and US domiciled investors being exposed to foreign equity risk assets in an environment where the dollar is rallying. That's a great synopsis.
And again, I do appreciate your time on this, and I look forward to having you back in terms of what we see develop over the next several months. And I think you and I would both agree that during times of this volatility, it's definitely not the time for investors to panic or to do unnecessary sales. But it's one to kind of take a step back, look at the bigger picture and recognize that with volatility comes opportunity.
You've really laid out some very good options for our advisors and our clients. And it's very similar to what we think in as well in terms of our house views. So thank you so much for joining me.
And I look forward to either being with you on Bloomberg again or having you on a podcast in the near future. So thanks so much. Let's do it.
It's that military cliche, you know, slow is smooth and smooth is fast. That's exactly right. Yeah.