From BlackRock to Vanguard, Managers Move Before Fed Acts

(Bloomberg) — While the financial world waits for the Federal Reserve’s announcement on monetary policy Wednesday afternoon in Washington, some of the biggest bond-fund managers have already made their moves.

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They anticipate Fed Chairman Jerome Powell will confirm their expectations, based on his determined signaling that rates will rise for the first time since 2018, likely starting in March, to combat the fastest inflation in four decades. With the economy recovering from the pandemic’s disruptions, everyone knows the central bank at some point will withdraw a lot of the bountiful liquidity its provided through quantitative easing.

In advance of Fed action, Vanguard Group Inc. is looking at floating-rate debt, BlackRock Inc. is heading toward neutral duration, and Pacific Investment Management Co. sees some attractive reopening trades in fixed income. Here’s what people handling trillions of dollars in assets under management expect to hear from Powell, and what they’re doing about it:

BlackRock (AUM: $10 trillion)

The Fed will “try to convey a very, very measured approach,” Marilyn Watson, head of global fundamental fixed income strategy, said in an interview on Bloomberg TV’s Surveillance. “They are going to try to outline a very measured path in terms of ending QE, which should be in March, and potentially a liftoff (on rates) in March.”

Balance sheet reduction “doesn’t necessarily mean particularly higher yields, whether it begins in the second half of this year or progresses into 2023 or beyond,” she said. “The market is already pricing, maybe overpricing, the level of interest rates for this year. It is pricing in four hikes. That might be a little bit excessive.”

The money management firm is shifting duration somewhat in its bond portfolio. “In terms of duration, we are starting to go a bit closer to home in terms of the interest rate sensitivity around our portfolios,” Watson said. “Where we had been short or underweight in Treasuries, for example, we are now a little bit closer to neutral.”

On the economy, “we do expect growth to remain robust and strong, but there are increasing headwinds at the moment. There is more uncertainty around issues with Ukraine, there are more uncertainties given the slowdowns in various areas, given omicron.”

Vanguard (AUM: $8.5 trillion)

Vanguard is forecasting one rate increase per quarter from near zero until interest rates reach the 2% to 2.5% mark. With valuations on the full side and volatility generated by interest-rate anxiety, the asset-management firm is expecting credit spreads to compress from these levels as the Fed begins withdrawing support, said Chris Alwine, head of credit.

“Policy tightening does not derail the economy,” Alwine said. “History has shown that the announcement and the introduction of tightening is associated with wider spreads. And we’ve been living that.”

Vanguard is prioritizing loans, in part because they can have floating rates to protect against the coming increases, according to Alwine. It’s also focusing on so-called rising stars, junk-rated companies on the cusp of investment-grade, and pandemic sectors that haven’t fully recovered, like airlines.

“For 2022 we’re cautious,” he said. “It’s a year of patience in our view. It’s not a year to be going up in risk.”

Pimco (AUM: $2.2 trillion)

Mohit Mittal, managing director and portfolio manager, is underweight public credit and has been reducing exposure over the last few months, though he is optimistic about the trajectory of monetary policy.

“We remain constructive in the central bank’s ability to tighten monetary policy from an extremely accommodative level,” he said, adding that “it’s important for us to not only focus on economic outlook and inflation outlook, which feeds into central bank policy, but also recognize that valuations are very, very important and focus on what the valuations are telling us about this trajectory.”

Areas that are starting to look interesting to Mittal include exposure to travel and transportation, such as airlines and cruise lines, through secured bonds and high-quality hotel debt, he said. Top-rated collateralized loan obligations and collateralized mortgage-backed securities are also attractive. He also sees opportunities to add exposure to private credit.

Nuveen (AUM: $1.2 trillion)

Some investors are straying away from high-grade corporate credit as the volatility that often comes with higher rates threatens to reduce returns. Since late last yeare, Nuveen has looked to decrease some of the risk tied to higher quality, longer duration spreads by keeping duration shorter than its benchmarks, said Tony Rodriguez, head of fixed-income strategy.

“These are not dramatic moves,” Rodriguez said, adding that the market is still “debating whether or not to be surprised” about the Fed’s decisions.

Rodriguez is expecting the central bank to maintain a “modestly hawkish rhetoric” without any tightening until its March meeting.

Western Asset Management Co. (AUM: $492.4 billion)

“A little bit of a volatility here and a spike in the equity market is certainly not going to make us turn the portfolio,” said Walter Kilcullen, head of U.S. high yield. Kilcullen has conviction that some so-called fallen angels, as companies that lose investment-grade status are known, will return to high-grade after suffering from the wave of downgrades that took place during the pandemic. He’s also paying special attention to risk-heavy sectors including air travel, cruising and gaming.

Kilcullen isn’t expecting the Fed to “make any promises” on Wednesday, but said Powell’s speech on the state of the economy will be closely followed. Inflationary pressures offset in part by lower unemployment rates, supply-chain disruptions and recovering wages are already impacting the earnings of blue-chip companies and beginning to spill onto high-yield ones, he said.

Elsewhere in credit markets:

Americas

The Bank of Canada held interest rates unchanged but signaled it could tighten monetary policy in coming weeks to contain the highest inflation in three decades.

U.S. junk bonds are poised to post the biggest monthly loss since the onset of the pandemic in March 2020 after yields rose to almost 5%, the highest in more than 14 months
Contact lens manufacturer ABB/Con-Cise Optical Group LLC faces increased refinancing risk as the Covid-19 pandemic continues to weigh on its sales
For deal updates, click here for the New Issue Monitor
For more, click here for the Credit Daybook Americas

EMEA

The shorter the better is the mantra for debt investors protecting themselves from the wild volatility in markets so far this year.

Public sector issues for Finland, EIB and Germany’s State of Brandenburg are among the deals keeping Europe’s primary bond sales open on Wednesday, as market attention shifts to a key U.S. Federal Reserve meeting.
Squeezed by soaring yields and potential government price caps, European utilities are making a dash to the bond market
Immofinanz management said in a statement that a mandatory takeover offer by CPI Property Group carries a too-low price and shareholders should reject the offer

Asia

Asian corporate bonds have been spared this week’s broader market rout, with a relief rally in Chinese debt that’s offsetting the impact of U.S. policy tightening.

Spreads in a Bloomberg Asian dollar-denominated debt index, of which Chinese notes are the biggest component, narrowed 2 basis points this week
That contrasts with premiums on high-grade U.S. debt, which have widened to the most since December 2020
Meanwhile in primary, issuers have mostly remained on the sidelines ahead of the Fed decision later in the day
Distressed property company China Evergrande Group is holding a conference call with investors

(Updates with comments from Kilcullen in Western Asset section)