Corporate Bonds

There are two key risks that could derail a bear-flattening of the yield curve. The first is a Trump election victory, the second is a flaring of stress in the non-U.S. banking sector.

It's hard to make a case for attractive returns from any asset class over the next year. We dial down risk a bit but ending our overweight on junk bonds. Investors should pick up yield where they can but without taking excessive risk.

Although the Fed is on track to hike rates in December, the credit cycle is far more advanced than the monetary tightening cycle. Position for a December rate hike by being short duration and in curve flatteners. Weakening corporate balance sheet fundamentals mean the long-term trend is for corporate spreads to widen.

The fiscal spending impulse in China is still positive but receding. The nation's productivity and potential GDP growth are bound to decline due to a rising role of government in capital and resource allocation. Hence, cyclical stabilization could well be overwhelmed by a structural slowdown. Another bubble is forming in China, this time in the corporate bond market. The amelioration in Korean and Taiwanese exports is due to the technology sector/semiconductors, and does not reflect broad-based improvement in global trade.

This week, we are introducing a new investment benchmark index that includes all the countries and sectors that we regularly cover in our research, and a detailed recommended portfolio that fully reflects our market views.

EM corporate credit spreads are too tight according to our fair value model. Such expensive valuations in conjunction with a strong sell signal from our Corporate Financial Health (CFH) Monitor signify that the EM corporate credit market is very vulnerable. The CFH Monitor currently heralds a major relapse in EM risk assets. A new relative value recommendation: long Russian and Chilean / short off-shore China corporate credit.

The Fed is sending signals that another rate hike is coming, despite sluggish U.S. growth and modest inflation, while both the ECB and BoJ are facing questions about the ability to maintain the pace of bond purchase programs. Amidst all this uncertainty, bond risk premiums can rise further in the near term.

The Treasury curve will bear-flatten between now and a likely December rate hike. Beyond December, our strategy will depend on how the dollar responds to increased rate hike expectations. For now, maintain below benchmark duration and favor convexity risk over credit risk.

With recent comments strongly hinting that the Fed is on track for a rate hike in December, the dy-namics of the Fed Policy Loop make spread product appear extremely vulnerable.

The euro area's NPL problem is unlikely to be solved quickly, constraining bank profitability and the capacity to lend. There are three important repercussions for investors.