MSIM favours European over US, Japan debt

Though Europe is languishing in the economic doldrums, fixed income from the continent offers value as interest rate risk is comparatively low, said Jim Caron, portfolio manager for global fixed income at Morgan Stanley Investment Management.

He is similarly enthusiastic about debt in commodity-based economies, but downbeat on Japanese and US fixed income.

Real yields are relatively high across much of peripheral Europe, with high-yield bonds returning close to 4%, and issues dated 10 years and longer producing real yields of 2% to 3%, chiefly because inflation is close to 0%, he noted.

European debt is attractive because interest rate risk is lower in Europe than the US, as the former is only just preparing for large-scale quantitative easing, whereas the latter has completed its QE programme.

There are a lot of sovereign opportunities in Europe, particularly at the longer end of the spectrum, he said. Caron favours investment-grade financials because policy, such as the buying of asset-backed securities, will be supportive. He also said asset-backed securities look attractive because the European Central Bank is preparing to buy them.

He is also keen on debt in commodity-driven economies, such as Australia, Canada, New Zealand and Norway.

As economic growth in China slows, commodity demand will also slow, Caron said. Energy self-sufficiency in the US will also dent commodity demand. Monetary policy will therefore likely stay loose in these economies, he added.

“Their bonds are some of the highest yielding AAA rated [issues] in the world,” he added.

However, currency risk is an issue because these countries’ currencies will depreciate as growth tails off, Caron noted. “The commodity cycle continued to rise through the financial crisis, so those economies were relatively well bolstered,” he said.

Meanwhile, US Treasuries hold little value, with yields having come down and the US Federal Reserve likely to raise interest rates next year, Caron argued. Also, though Japan is unlikely to raise rates any time soon, Japanese government bonds aren’t paying enough in coupon income, he added.

“I’d be more underweight on Treasuries and JGBs,” he said, though as interest rates are likely to rise slowly, assets with some spread component could offset interest rate risk.

The yield for five-year JGBs was 0.11% and for 10-year JGBs 0.44% yesterday, and for US Treasuries it was 1.6% for five years and 2.25% for 10 years.

Following Japan's doubling down in its efforts to fuel growth, Caron argued that the country had made the mistake of not going far enough when it recapitalised its banks in the late 1980s and early 1990s.

“That’s not enough. The three steps after a crisis are: recapitalise the banks, de-lever them, then re-lever them,” he said. “Japan never really had a programme where they could dispose of non-performing loans quickly.”

He said the US learned from that experience, and introduced the Term Asset-Backed Securities Loan Facility in 2008, which saw the Federal Reserve Bank of New York lend to holders of asset-backed securities backed by loans to consumers and small businesses.