“The biggest opportunity is in corporate bonds”

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The credit sector is more interesting than governments, while bond markets have generally normalized after a decade without unconditional central bank support, explains Gabriele Foà, portfolio manager at Algebris Investments, a management company with around 25 billion euros in assets under management.

Given the recent turmoil in the markets, what is your outlook for interest rates?

Central banks are shifting their attention from inflation to the economy, which is showing signs of slowing down. Compared to 2023, when deflation was driven by a few volatile sectors, now all components are falling, including residential and services. However, the economy is showing signs of fatigue. In Europe, Germany will not grow this year and manufacturing data are worrying. In the United States, the job market has slowed down. In recent days, the price chart has begun to reflect a recession and multiple interest rate cuts by central banks. This conclusion is too extreme, and the volatility in August has exacerbated it. However, we believe that the Fed and the ECB are likely to cut interest rates two or three times.

The second half of the year is marked by the US election. What consequences do you foresee?

Both parties have expansionary fiscal proposals. The US deficit reached $1.7 trillion in 2023, the highest level in the post-war period. Whoever wins will face a debt vortex, and the market’s attention to this issue has gradually increased. There are other key issues in the Republican platform, such as the imposition of tariffs and tariffs (which may have a significant impact on inflation and currency markets), and a less active approach to foreign policy. In both cases, the government’s presence in the economy will increase, and a Republican victory will be more conducive to economic growth, although with greater volatility.

So the interest rate cut is an expansionary fiscal policy. What is the impact on bonds?

The most obvious is the steepening of the curve. The short end of the curve can be supported by cuts, but this does not always translate into support for longer maturities. Higher long-term inflation expectations and more issuance to finance rising deficits weaken higher-maturity bonds. Despite falling interest rates, it is still necessary to be very cautious about government bonds and duration. In addition, the market has already digested more rate cuts than it is reasonable to assume, and interest rate volatility remains high. Bond markets become difficult after 2021.

So the bond market is back to being a difficult and volatile one. And credit?

The combination of rates and spreads means that credit returns are more interesting than government bonds, and with growth decreasing but positive, it is the most valuable part of fixed income, although not everywhere. Investment grade follows rates as it reprices and now offers smaller spreads. On the high yield side, there are both opportunities and risks.