Fixed IncomeJul 15 2013

Trade of the week: Fixed Income

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The US Treasury market has reacted strongly to the possible slowing in bond purchases with a knock-on effect on asset class valuations.

After this significant adjustment, some bond valuations are no longer quite as expensive.

There is debate about the end of monetary stimulus. The Fed continues to draw a line between scaling back quantitative easing and actual changes in interest rates, which remain unlikely in the near future.

No one really knows to what extent massive bond purchasing, and its imminent slowing, will affect valuations of asset classes and currencies.

The adjustments to nominal yield levels, real yields and the shape of the yield curve by markets in the past few weeks leaves room for opportunities; inflation-linked government paper, nominal government bonds, and high-yield and corporate debt look promising again.

Corporate bonds are attractively valued following a revaluation and consolidation of bond markets and risk premiums. The increase in risk aversion and the tendency towards profit-taking on corporate credits is tempered by positive factors: corporate fundamentals look good, default rates are low, and the growth rally is likely to have a positive effect on results.

We currently favour financial sector covered bonds and industrials over utilities. But the risk premiums and structure of each bond must be analysed. Corporate risks should be mitigated by extensive diversification.

Bernhard Urech is head of fixed income interest rates at Swiss & Global Asset Management