Fixed Income Conversation Corner with Matt Brill (Invesco) and Leslie Falconio (UBS CIO)
The desk interprets recent commentary from UBS's Leslie Falconeo and Invesco's Matt Brill as reflective of a cautious sentiment in the fixed income market, notably surrounding the geopolitical uncertainties and their subsequent impact on investment-grade corporates. Per the full note, the ongoing conflict in the Middle East has primarily influenced commodity prices rather than broader credit market performance. The commentary suggests that investors should focus on ongoing risks but maintain attention to the resilience of the investment-grade sector amidst external shocks, as these factors could ripple through to trading in related asset classes.
What the desk is arguing
The desk identifies the current geopolitical landscape as a significant variable influencing fixed income markets, especially in investment-grade credits. Matt Brill emphasized that while the humanitarian crisis in the Middle East is paramount, from a pure market perspective, it acts largely as a distraction that primarily affects commodities rather than driving overall market sentiment.
Furthermore, the commentary highlights that while these geopolitical tensions weigh on market perception, they have not precipitated drastic moves in credit spreads. From this, the desk argues that the investment-grade sector will likely remain resilient, with a focus on credits that can withstand broader market disturbances.
Where it sits in our coverage
Our consensus target for related investment-grade credit spreads sits at 1.075, with a range between 1.04 and 1.12. Notable targets among peers include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This desk's view aligns closely with jpmorgan, positioning at the upper bound of the spread, indicating a more optimistic outlook versus bofa's more cautious stance.
How other firms see it
Aligned firms, including jpmorgan, are adopting a cautiously optimistic view on investment-grade credits given the current geopolitical situation, while bofa presents a more bearish outlook. The divergence between these perspectives is notable as firms assess the potential fallout from ongoing conflicts.
Market dynamics in related currency pairs, such as USD/TRY and EUR/ISD, may also reflect similar sensitivities to regional geopolitical developments, as they are influenced by changes in risk sentiment in the broader fixed income landscape.
01Geopolitical tensions are affecting commodity markets more than credit spreads.
02Investment-grade corporates show resilience, able to withstand external shocks.
03The credit market should focus on performance drivers amidst rising global uncertainties.
04Different firm perspectives illustrate varying expectations for the investment-grade segment.
Market implications
Traders should monitor investment-grade spreads, particularly around the consensus target of 1.075, as market reactions to geopolitical news could drive fluctuations around this level. Additionally, the trajectory of USD/TRY may provide insights into how credit market shifts influence currency movements.
Risks to this view
A significant escalation of geopolitical tensions could instigate a shift in market dynamics, leading to broader credit spread widening and potentially triggering a sell-off in investment-grade securities. This would force a reevaluation of current positions as the economic outlook becomes more precarious.
ubs
Hi everyone. Dan Cassidy here. Welcome back to the UBS Market Moves podcast channel.
Today we are continuing with our monthly Fixed Income Conversation Corner series. Joining us for this month, glad to welcome from Invesco, Matt Brill, Head of North America Investment and Great Credit and Senior Portfolio Manager. Joining us from the UBS Chief Investment Office, glad to welcome back, Head of Taxable Fixed Income Strategy for the Americas, Leslie Falconeo.
So with that, Leslie, let me now turn it over to you to lead today's episode with Matt. Welcome back. Thank you, Dan.
And Matt, it's been so great to have you on. I mean, first of all, you're on the media quite a bit. I think you and I have been on Bloomberg together once or twice, but it's been such an interesting time for the sector, particularly when it comes to investment-grade corporates and what we're seeing in hyperscalers.
So I'm looking forward to this conversation. So thanks for taking the time. I know our clients and advisors are really going to enjoy this podcast.
Well, thanks for having me, Leslie. Good to chat with you again. Absolutely.
So let's just get into it. Let's start with, first, say, the most obvious thing on the table right now, which people are talking about, in regards to uncertainty. And that's like some of the political events we've seen and the conflict that we've seen in the Middle East, a lot of the disruptions to the financial market.
How do you sort of look at that and the impact that it's had, say, on overall investment-grade corporates? Yes, I think when we look at what's happening over in the Middle East and kind of the continuous conflict that we thought maybe was over but then wasn't over and just kind of continues to drag on, it's a little bit of a distraction. I would say the humanitarian aspect of it, we got to put aside and just think pure markets.
And it's not really driving a whole lot within the market other than commodities, which is important. But the main theme that we want to be thinking about is AI, and that's going to be the long term. The impact of artificial intelligence is going to be the impact long term.
Now, the near-term impact being caused by higher oil prices and higher commodity prices from the Middle East is important, but I think it will be less lasting in the long term. But over the near term, it is causing the Fed to have to even consider hiking over the near term. If you look at inflation, it's gone up.
Oil prices have gone up. But not all of that is coming simply because of the conflict in the Middle East. You're seeing commodity prices go up just from the demand.
You think about memory prices and things like that from chips and everything that have been being driven up as well. So there's a lot of different reasons why prices are going up. But there was a little bit of a tailwind finally when we started to see the ceasefire there, and it felt like, okay, maybe we can now get some of the price of oil back to normal, and we can only worry about the isolated impact of AI.
But now we've got two things to worry about, unfortunately, from a price standpoint. But I do think it will pass, and it's going to cause a little bit of volatility. Midterm elections are obviously on the horizon as well.
So there's always going to be something to worry about in that regard. But underneath it all, the overall economy is pretty strong, which is what we're most encouraged by. Are you surprised at all?
I mean, listen, spreads haven't really moved that much in the corporate market. And look, we know that spreads aren't the best predictor of total returns about the yield compounding into coming to carry, which we know has been a great tailwind. I know that rates have been a headwind a bit to some of these sectors year to date.
But overall, if you take that full year of carry, in our opinion, you're still going to be doing pretty well. Are you concerned at all with how contained some of these spreads have been given this uncertainty? And what performance drivers do you think will dominate from now, say, over the next six months?
Yeah, I mean, it's been pretty phenomenal how the markets just really looked through all the uncertainty for sure thus far. The longer it drags on, the longer oil prices stay high, I think there could be some cracks. But the U.S. is pretty resilient and pretty commodity price independent, particularly from an oil standpoint, from a gasoline price standpoint.
So we are better protected than other countries are in that regard. You're going to see more impact in Europe as well as in Asia. But for the U.S., the commodity impact is significant, but not going to drive things on a day to day basis.
Spreads are tight, no way around it. We look at spreads over near term, over long term, they're on their tighter end of the range. We think they're justified to be tight though, because fundamentals are very strong.
You're actually still seeing more upgrades and downgrades. Within investment grade, you're seeing more rising stars, companies coming out of high yield into investment grade, more of those than what we call fallen angels, which are coming out of investment grade to high yield. So the overall credit trends are positive.
Defaults are low. Downgrades are low. Ratings migration is positive.
So we feel like it's justified. However, what's really driving it in our opinion is, I mean, the fundamentals are great, but it's just the all in yield. So I think most investors, when they buy a bond, they think about the yield that they're getting, not so much the spread or the additional income they're going to get over treasuries.
They're just thinking about the all in yield. And because all in yields are high, we're continuing to see inflows. And we're seeing more inflows on the institutional side rather than on the retail side.
But on the institutional side, insurance companies, pension plans, annuities, they're all buying high quality fixed income. And that is why you continue to see spreads stay tight. If we were to see any kind of fundamental cracks in the economy or in the credit markets, then you would have to see credit spreads back up.
But overall, we're not really seeing that right now. And everything that you're seeing out of the Middle East, it's impacting certain segments of the economy, particularly the low end consumer. But the job market's pretty good.
So the job market's pretty good. People continue to be employed. So while discretionary income isn't quite where everybody wants it to be, overall, it's still pretty decent.
So we think the economy's in the kind of shape right now that's leading to spreads being warranted to stay this tight. And as long as yields stay elevated, we think spreads will continue to remain in this level. So when we think about it, and I think you bring up some really great points, we completely agree, by the way.
It's all about that yield that you're earning. And that's why I think people are so interested in the investigative corporate side. And it provides an incredible cushion in terms of when you look at breakevens, that interest rate component that's in the IG corporate side, because it's a combination of credit and interest rates.
There's a really good cushion there. But let's talk about the 10-year for a moment, just because we've had, obviously, a decent rise in the past couple weeks. Most of them, by the way, driven, as you know, by real yields moving higher.
And I know we'll get to the Fed in a minute, but we have a higher terminal. Growth, as you mentioned, is still going strong. How do you view that 10-year from now, say now to the end of the year?
Are you thinking that at these levels, do you believe there's a risk that we have this breakout to the upside? Are you more into the, we'll fall back into that range by the end of the year once we get some of the more economic data, particularly on the inflation front? Yeah, I think we're in the range.
It's hard to define where's the high end of the range, but I don't see us going higher than 5% on the 10-year treasury. I think four and a quarter to four and a half was our general range that we've been in and we like. Our call was to stay in that.
We've crept a little higher than that on some negative news out of Iran, some negative news on the budget deficit. You've seen just a little bit more funding needed by the U.S. government, but overall, I would say that we're still, we think at the higher end of that range. You had 460 around there today.
We got as high as 470. It does feel to me like there is buying support. Anytime you start getting closer to that 5%, investors love that key round numbers, 5% to own pure treasuries, probably close to 6% to own corporate bonds.
These are yields that you haven't seen for a long time. We've gotten a little more used to in the last couple of years, but until 2022, you hadn't seen these yields for decades. For me, that buying power does step in.
I would like to see a little bit more talk around the midterm elections of budget deficits and balancing things, or at least having smaller budget deficits. I don't know that either side of the aisle really has the appetite for that, but if there's at least some recognition that we have to have some fiscal prudence, that would be nice. Overall, my belief is that we're in this range bound here.
The Treasury Secretary, Treasurer Scott Besson, he's stated numerous times that his number one priority is to drive that 10-year treasury lower. He wants that yield to be close to 4% to save the government money, but also for mortgages, to get people housing at a more affordable price. This is something that the government is really focused on.
It's nice from that standpoint to know that this is a priority. Now, can they take control of it on their own? No, but at least it's something that they're watching and something that they're cognizant of and wanting to be lower, which puts them in our camp.
Overall, to me, that means you can't really go too much higher on 10-year treasuries. If they go much higher, the government will or the Treasury will actually issue more and more front-end debt and make sure that the supply and demand out the curves remains in balance. Overall, we do think we're at the higher end of the range already and that we should trend back below that 4.5% at some point during the back half of the year.
That's very close to our level, too. We're on that 4.5% level. We agree with you and we know that we have the refunding announcement next week from Treasury Besson, which to your point, is they're really not expecting any changes.
Most of the issuance will be in that front-end of the curve and the market's not expecting really any coupon or back-end issuance until 2027. I agree. They keep an eye on that back-end.
We know the mortgage rates have, particularly this month, have gone up quite a bit. I think that whole affordability issue will become more of a topic of conversation, particularly as we get to the midterm elections. As we talk about interest rates, I think a lot of it, in the short term anyway, we have the Fed tomorrow.
The podcast might be out after the Fed meeting, but we do have the Fed tomorrow. I'm just curious as to, to your point, the first press conference, Warsh's spotlight is on that mandate of price stability. The market took it as a bit hawkish.
We have uncertainty regarding the lack of forward guidance from the chairman, even though the committee members haven't hesitated from stating their opinion. What do you think in terms of, not just tomorrow, but sort of how policy plays out from now to year-end, particularly given that hawkish tone that's already priced into the market? Kevin Warsh is certainly unconventional by design.
He seems to want less transparency, less forward guidance going forward. He's going to make us work hard to figure out what they're going to do and what they should do. I think tomorrow, the market currently has around a 30% chance that he hikes.
We're in the camp that he will not hike tomorrow, but it wouldn't completely surprise me. I think if you had asked me six months ago that President Trump's going to get his new appointee into the Fed chairmanship, and of course, he's going to cut rates, he's going to do everything the president wants, and that's not played out that way at all. I think people have been a little bit surprised by it.
In some ways, I think he's really pushing for the market to understand that he is independent. We've heard it all along, and he's going to say, I'm independent, and everybody somewhat believes that. If he does come out and hike tomorrow, I think that would really shock things.
One of the craziest things to think about if the Fed were to hike is that it doesn't make a lot of sense to most people, but you would actually probably see 10-year yields go lower if the Federal Reserve hiked tomorrow. The reason for that is that they're just telling you, we're going to do whatever it takes to get inflation lower, and that will be good for long-term inflation expectations, which will actually drive rates lower. Most people equate the Federal Reserve with the 10-year Treasury, that they're completely correlated, and they can be a lot of times, but they're not necessarily.
In a period like this, if it were to hike, I actually think 10-year and 30-year yields would go lower. I don't think he will hike. I think he's going to talk very aggressively, very hawkishly, though, and tell you that he's prepared to do anything that he needs to do in order to drive inflation lower.
Since the last meeting, we've only had one inflation print, and that was actually pretty good. You've seen inflation stay in check. Even with higher oil prices, it stayed in check.
I think it's really hard for them to go and do a 180 where they didn't hike last time, and then they actually got a pretty good inflation data, and then they're going to go ahead and hike again this time. I don't think that's going to happen, but I do think it's important to hear him continue to talk about how he's putting these committees together, and they're going to try to figure out how to drive inflation expectations lower, how to keep inflation in check. They've been failing.
It's their words that they've been failing on the inflation expectations and on inflation policy for the United States, and having it be north of 2.5% is too high for them. They've been failing the American consumer, the American employee, and they want to get that fixed. I think they're going to talk very hawkishly, but deliver a no action tomorrow.
We agree with you in terms of the action standpoint. There's a lot of uncertainty around it. We think that you're likely to have a hawkish hold with a few dissents to have the September meeting remain a live meeting.
I don't anticipate the 50 basis points of hikes the market is pressing in right now to get alleviated that much tomorrow. One thing I do slightly disagree with you though, Matt, is that I think if they do hike tomorrow, initially, in the long term, you're definitely going to have yields coming down, but I think initially you might have yields moving. You can have a knee jerk reaction higher, and then I think it'd be a great time to buy, but I do think the market will be caught off guard a little bit.
We're going to get into this in a minute as we talk about AI, because as you know, we've had the fixed income market saying one thing, the equity market acting as another, and I think that possibly that surprise hike might give a little jolt to the equity market and push yields higher, just for at least the short term before yields come back down again. Let's switch to the AI side. This has really been an important topic, not only for every strategist out there on the street, particularly for our clients, because we've had such headlines in terms of AI and CapEx and the buildup that we've seen and the impact that that has had on credit spreads, whether it's hyperscaler index, whether it's the crowding out theory or issuance in the long end, what that might do to the overall IG index.
I'm really curious, as to your take about CapEx right now, what this is going to be like going forward, because as you know, we've had some of these hyperscale issues, which a lot of them are prime in terms of their ratings. Some of them are a little bit shaky. We've seen some spread widening.
It's been one of the most exciting times in my career to be investing in corporate credit, just given the frequency and the opportunity set that's happening. It's happening at such a fast pace that it's actually making things cheaper, because there's just so many things to choose from, which too much of a good thing can be a bad thing. That's essentially what we're seeing right now, where historically, we might see one large deal every year.
We would find a large deal of $20 billion or more, a mega deal, as we call them. We might get one mega deal per year. We've gotten nearly 10 mega deals already this year.
Almost all of them, other than one, have been from the hyperscalers. You've seen Alphabet, somewhat large deal in the U.S., as well as in the U.K. and Canada, and even in Japan. You saw Amazon come multiple times.
You've seen Oracle come. You've seen Meta come. You've seen these large data center deals.
Even just yesterday or the day before, you saw what we call Sopa y Pizza, which is a Texas pastry or a Southwestern pastry. It's a data center in El Paso, Texas. It's basically backed by Meta or leased to Meta.
It was a $12 billion to $13 billion deal. We saw late last year, Binye, which was a nearly $30 billion Louisiana data center deal backed by Meta or leased to Meta. Again, it just keeps coming.
Some of these are incredibly attractive. The AA- deal yesterday for the Sopa y Pizza at nearly 7.5%. Historically attractive, looks very interesting, high-quality tenant, incredibly important to the company, but there might be another one in another week or another one in another month.
The market just is getting very saturated, and the indigestion is certainly real. You mentioned crowding out. This is real.
There's a lot of debt that is being issued, and there's only so many dollars in the world. Every time they come with a new deal, people may say, wow, I really like Amazon Credit, but I already own them. They may have to come again next year because roughly 35% of their CapEx budget for next year is probably going to be funded with debt.
You just continue to see that over and over. You've seen an increase larger than what we started the year with. Alphabet came into their earnings last week.
I think the market expected them to do about $190 billion this year. Earlier in the year of CapEx, they had expected them to do $160 billion, $170 billion. They came out and said, actually, we're going to do north of $200 billion.
Then next year, we're probably going to do $270 billion or somewhere around there. The numbers just keep going up. They keep needing debt for it.
They actually are incredibly lowly levered still to this point. Fundamentally, we feel very good about them. Just technically, there's just a lot of dollars being spent or being borrowed.
There will be a point where this stops. We are picking and choosing this because there are some tremendous opportunities. Like I said, you can buy single A, double A, high quality companies at 6% to 7.5%.
These are opportunities that we don't think will last forever, but there are a lot of them right now. You've got to pick and choose. Unfortunately, it's putting a little bit of pressure on the credit markets, but mainly just in technology space.
Historically, technology traded flat to inside from a credit spread standpoint. You've got less credit spread for owning technology names than you got for owning the rest of the bond market universe in the past. Now, you're getting an extra 30 to 50 basis points to own on average the tech space.
It's cheapened up. Cheapened for a reason. Technically, we don't think it's cheapened for a reason.
Fundamentally, we continue to like these names. We're just being very cautious and picking our right spots because we do think this is going to continue, but it is a great opportunity to get some really attractive credit at some very high yields. That leads into my next question here too.
When we look across the IG corporates, and I know you're mostly in Dolls and I'm in there, but even if you talk about or feel comfortable talking about what's happening in either EM and Europe as well, where do you see the best value? Not in terms of rating, curve positioning. I also know that Desco is very much present in the securitized side as well, as are we.
I know that's not your specialty nonetheless, but do you see crossover buying there? I'm just curious where you see your positioning and good pockets of opportunity in a sector that's widened a little bit, but not necessarily historically cheap. Yeah, there are abundance of opportunities from a yield standpoint, less opportunities from a spread standpoint.
We're trying to find where you can play this AI boom without having necessarily the negative technicals. We've seen it in the high yield market, classic US industrials that are benefiting from the build-out. Think about your construction equipment companies, your your typical Midwestern America industrial that is moving a bunch of dirt around and things like that.
They are benefiting very much from this, and we think they will continue to do that. You see in the IG credit markets, we like three areas. The first would be the bank.
Look at you guys. You're in a lot of these deals from an IPO standpoint, from a debt funding standpoint. There are a lot of different ways that you all are making money off of this AI boom and all the financings that need to be done to drive that or to pay for that.
We like the banks. We also think the banks are a little bit of a derivative of the economy, so as the economy does well, banks do well. Second, I mentioned the classic industrials.
That's in high yield, but we also like some of those in investment grade. That's going to take advantage of, again, the build-out, not necessarily the chips and all that, but more of the construction equipment, the moving of dirt, and just the overall CapEx budgets that are needed to build out the infrastructure there. The third is the power.
The amount of energy needed for the AI build-out is significant. It's not oil and natural gas, necessarily. It's more on the utility side of things.
We like the utilities. Anytime you get a large deal for a data center, it's typically a company by how many gigawatts of power are going to be needed for it. The demand for the power is significant, and these companies are doing quite well.
We like the banks. We like the traditional industrials and more of the manufacturing or the equipment space. Then last, we like the power.
What would be, with that said, I wanted to stop with some final thoughts. If you had to give some advice for longer-term hold investors, which they are, but definitely feeling the nervousness around uncertainty and potential volatility in the second half of the year, whether it's the new Fed chair, midterm elections, uncertainty regarding the Middle East crisis, what would be your piece of advice to those investors? Okay.
Our general thoughts are that yields are attractive. Yes, you can get decent yields on the front end, owning cash and the like, T-bills, etc. These are tremendous opportunities we think that you can take advantage of and put in your clients' hands for a number of years by locking in yields where they are today.
High-quality, single-A, triple-B investment-grade credit can get you 6% pretty easily right now. We like that. We think there will be some volatility, yes, but you're going to weather that.
Because the fundamentals are good, you're going to look up in three months and be happy that you've locked in some of these yields. We do think at some point in the future, the Fed will actually get back to cutting. We do think rates will then be lower.
With that, you will be better off by owning things other than cash and stepping out of the curve. Our general thought is that you can buy intermediate fixed income, clip that 5.5% to 6.5% range and do quite well. From that standpoint, we think it continues to be an opportunity.
Yes, you want to have a diversified portfolio within fixed income, but you do want to have some term debt, which we think looks pretty attractive right now. Well, thanks, Matt. That's a great way to close.
I appreciate your time. This has been a very informative podcast. I look forward to the next couple of months and see what's changed and having you back on again.
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