Beyond Bulls & Bears

Focusing on Fixed Income

There was once a time—perhaps not too long ago—when fixed income markets were considered to be the unobtrusive, quiet guest at the dinner party. If equity markets were seen as raucous and exciting, fixed income was instead the steady, sure friend who rarely caused any commotion.

My, how things have changed.

Today, much of the investing world’s news is focused on unexpected developments in fixed income. Roger Bayston, Director of Fixed Income for the Franklin Templeton Fixed Income Group®, chatted with us to discuss some recent fixed income themes.

Roger Bayston
Roger Bayston

Beyond Bulls & Bears: Roger, the European sovereign debt crisis has really been dominating the news lately. How do you see that impacting U.S. fixed income markets?

Roger Bayston: Concerns over the European debt crisis and related worries regarding a possible restructuring of some financial institutions’ debt holdings— or even some countries’ sovereign debt— raises questions about expected growth in the United States. That feeds into a cycle where risk-based assets are generally avoided, credit spreads increase, and some investors lose their comfort level in investing in riskier assets. In addition, as investors shun what they perceive as risky assets, there has been a flight to assets seen as safer— such as Treasuries. This has kept long-term U.S. government interest rates low, despite the recent credit downgrade.

Beyond Bulls & Bears: Are you seeing any impact as a result of the Fed’s “Operation Twist” on U.S. mortgage rates?

Roger Bayston: “Operation Twist” basically means they’re going to be buying longer-term U.S. government debt in an effort to keep long-term rates low. Essentially, now that the Fed has arrived at a zero interest rate policy on short-term rates, they are continuing just to reassure the market that they will serve as the buyer of last resort, to make sure that monetary policy remains intact, that they are going to be supporting the U.S. financial institutions and the U.S. economy by attempting to keep longer-term interest rates down.

It does help the economy on the margin by keeping other borrowing costs to corporations as well as mortgage financing rates for U.S.households at a lower level.

Beyond Bulls & Bears: Do you see that having any potential impact on a U.S. housing market recovery?

Roger Bayston: I don’t think a housing market recovery is going to be purely driven by mortgage rates, which are ultimately the beneficiary of the Fed’s new efforts. Fundamentally, an improvement in the housing industry is going to be a function of jobs, and until the unemployment rate moves lower, it will likely remain stagnant.

Beyond Bulls & Bears: Where do you see rates and credit spreads heading next?  And where are you finding value?

Roger Bayston: We know the Fed’s already told us that short-term rates are not going to go anywhere anytime soon. I think, by and large, we are going to be in several months of uncertainty related to the resolution of the European sovereign debt crisis and some of the financial institutions in Europe that need to be restructured. During this period of uncertainty, I believe credit spreads in the U.S. are going to remain relatively wide versus the fundamentals and we should see some opportunity due to this dislocation.

Beyond Bulls & Bears: Given current market conditions, what’s your outlook as we head into the end of the year?

Roger Bayston: The market seems to be pricing in a recession in the U.S. and much higher default rates on corporate credits than what the fundamentals suggest. Many corporations in the U.S. are showing resiliency in their balance sheets; they have deleveraged over the past several years, so we are seeing opportunities in certain credit investments.

We expect that we are going to have a bumpy ride in the fourth quarter, but we think that getting the income benefits from those corporate debt securities may be a good opportunity right now.

Additionally, we continue to like some global investments, and we think diversification in global fixed income right now makes a lot of sense.

Beyond Bulls & Bears: It always comes back to diversification. Thanks Roger.

 Until next week, Beyond Bulls & Bears leaves you with a quote from Sir John Templeton:

“To avoid having all your eggs in the wrong basket at the wrong time, every investor should diversify.”

Important Legal Information

Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. The use of derivatives and foreign currency techniques involve special risks as such techniques may not achieve the anticipated benefits and/or may result in losses. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.


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