Fixed income on the rise. But the mantra remains "diversification"

According to Salib (Federated Hermes), the market is ready to take off. However, relentlessly pursuing maximum performance can be counterproductive. It's better to invest across multiple segments and reduce risks. From emerging markets to real estate, here’s what to focus on

by Giulio Zangrandi

With the Federal Reserve surprising analysts by cutting U.S. rates by half a point, everyone is betting on a new season of success for fixed income. This asset class seems to have regained its historical decoupling from equities and now promises to provide shelter from market turbulence once again. However, drawing heavily from such a broad and diversified pool could prove to be a risky choice for investors. This is especially true given the many uncertainties that remain on the horizon, starting with the upcoming American elections. That’s why Ihab Salib, head of international fixed income at Federated Hermes, believes that the key word remains diversification. This is a perspective that the editorial team at FocusRisparmio asked him to elaborate on.

What prospects does the Fed's recent decision to cut rates by 50 basis points open up for fixed income investors?

In reality, this changes less than someone might think: it is more a matter of consolidation. It was already known that the Fed was ready to start a new season of monetary easing; it is more a question of how long and with what intensity the US central bank will continue this initiative. In general, therefore, I would say that we are at a very positive moment for the market, although there are still differences between the various segments. Those who invest in fixed income will probably be happier at the end of next December and beyond than they were a year ago.

Are there sectors or geographies that can benefit more than others from this scenario?

Lower interest rates tend to support risk assets, although much depends on why rates are being cut. In a case such as this, where central banks need to ease monetary policy by shifting the trajectory of the economy from recession to a soft landing, emerging markets may therefore be the first to benefit. As far as the developed world is concerned, one of the market segments that will see the biggest recovery is real estate: US mortgage rates should actually fall, encouraging a new season of underwriting after the immobility that accompanied monetary tightening. I also expect to see a recovery in the US automotive sector, where interest rates for financing new cars were much higher than they have been in the past are hovering around 8%.? If they go down to 3-4% that should spur activity in the new car market.

What will be the impact of the US elections?

The policies advocated by the two candidates on the campaign trail suggest that markets could move in different directions if either Trump or Harris wins. For example, with the Republican leader in the White House, many expect more government debt and more fiscal stimulus: this means a boost to economic growth, for example in energy production, but also more volatility and a less favourable environment for bonds. If, on the other hand, the new president is Harris, sectors such as infrastructure and sustainability are expected to benefit.

In general, however, I think that the US economy's trajectory will be less negative than expected: by cutting rates by 50 basis points, the FED has indeed made it clear that inflation is no longer the only priority and that from now on it will also be necessary to focus on the labour market, a circumstance that gives substance to the hypothesis of a soft landing. What I expect, therefore, is an overall stable GDP, albeit with a contraction in the course of the year on a quarterly basis.

Given this scenario, what is the best approach for those wishing to invest in fixed income?

In a period like this, characterised by high volatility and sudden market turns, the right approach can only be not to try and time the market. This means not always aiming for maximum performance, which would mean taking on more risk, but also investing in different segments of the market that could benefit regardless of what happens to risk assets. ?Diversification of risk and within a specific product should be of key consideration. This is exactly what we do with the Euro Kurzl?ufer fund, which we recently registered in Italy.

What is this specifically about?

This is a fund launched 25 years ago with one of our German partners and aims to outperform bank deposit rates by investing in the global investment grade segment. It is therefore a product with a duration of between six months and one year. Meaning this will have limited credit risk and interest rate risk. Focusing on high-quality securities in a wide range of sectors, regions and countries is the example of this diversification.