When investors recall the third quarter of 2018, many may cite the fractures that occurred in certain corners of the fixed income market. In PGIM Fixed Income’s fourth-quarter outlook, we evaluate the extent of the damage, the factors that contributed to the periodic volatility, how these issues may unfold going forward, and the nature of the opportunities that lie ahead.
With the exception of global leveraged finance and U.S. stocks, many markets have encountered tough times in 2018. Despite the Q3 bounce in the fixed income spread sectors, it wasn’t enough to undo the damage from the first half of the year. On the rates side, yields either moved sideways or higher—significantly so in some cases. In currencies, the U.S. dollar has been the biggest beneficiary of the anxious market backdrop. And across markets, idiosyncratic fundamental vulnerabilities and policy missteps brought on stiff punishment from the markets.
Going forward, PGIM Fixed Income sees opportunities in fixed income, but more so from a vantage point of relative value and less so from an absolute, raw-value perspective. With essentially the same set of threats from the first three quarters of 2018, the market backdrop is likely to stay choppy, yielding both risks and opportunities in yield curve positioning and sector allocation, as well as issuer and currency selection.
At a glance – PGIM Fixed Income sector views as of September 30, 2018
| Sector | Outlook | Rationale |
| Municipal Bonds | Positive | Favorable technicals by year-end should lead to outperformance versus Treasuries. |
| Structured Products | Positive but Selective | Long-term positive on top-of-the-capital structure structured products, especially CLOs and CMBS. Still content to earn carry at current spread levels. Negative on conduit CMBS and CLO mezzanine tranches. Increasingly looking at financing trades, rather than exposure to the underlying assets, as spreads are tight and the demand for leverage is high. |
| Global Leveraged Finance | Modestly Positive | Modestly positive on U.S. high yield in the near term, but cautious longer term with spreads at post-crisis tights and broader macro concerns. Due to their higher historical recovery values, we believe U.S. leveraged loans have less downside risk at this point in the cycle relative to U.S. high yield bonds. We are near-term positive on European high yield with expectations for spreads to tighten modestly from current levels amid supportive macro conditions, solid fundamentals, and earnings growth. |
| Emerging Market Debt | Cautiously Optimistic | Cautiously optimistic based on valuations, a decent global growth outlook, and adjustments that have already occurred. |
| Developed Market Rates | Opportunistic | Long-duration positioning in the U.S. comes amid an expanded trading range given the multiple uncertainties in the background. Continue to favor modest widening in U.S. swap spreads and tighter spreads in Europe. See 10-year Bunds near the mid-point of our forecasted range and an expanded trading range for JGBs. |
| Agency MBS | Neutral | Neutral versus rates and underweight versus other spread sectors. Remain up-in-coupon for carry. Prepayments should remain slow. Avoid TBAs. Favor seasoned pools for better convexity and Freddie Macs as we near Single Security implementation. |
| IG Corporate Debt | Cautious | Cautious given increased downside risks and the potential for spreads to widen despite favorable fundamentals and earnings growth momentum. Still favor U.S. money center banks. U.S. tax reform remains supportive |