Fixed Income Outlook: Second Quarter 2016

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by: Neuberger Berman

By Neuberger Berman Asset Allocation Committee

High yield, particularly short-duration issues and higher-rated credits, remains in favor given current prevailing yields and the outlook for credit quality.

Global Fixed Income

Treasuries: While we continue to evaluate the durability of the U.S. business cycle, recent data suggests that the fourth quarter was a temporary soft patch for the U.S. economy. Importantly, job growth remains robust with an average payroll gain of 252,000 over the past five months. As such, we anticipate a couple of rate increases during the year; the Federal Open Market Committee moved closer to this viewpoint in March as the median number of expected rate hikes in 2016 declined to two. Overall, we believe U.S. rates will be range-bound. On one hand, dialogue about the potential to overshoot the 2% inflation target could push rates higher. However, U.S. dollar strength is setting a speed limit on interest rates, due to the stress it puts on China and emerging markets more broadly.

Developed Market Non-U.S. Debt: Negative interest rate policies in Europe and Japan continue to have massive implications for global sovereign debt. Due to interest rate differentials and wide-ranging policy stances, we anticipate divergent trends across developed market non-U.S. debt. Additionally, the increasingly volatile currency dynamics we've witnessed in recent months will likely continue to have an impact going forward.

Global Purchasing Manager Indices Imply a Soft Patch

Source: Bloomberg. Data as of February 29, 2016.

High Yield Fixed Income

We continue to hold a slightly above normal return outlook over the next 12 months for high yield fixed income, and see opportunity in the category given elevated yields and potential for spread tightening. While the environment may remain volatile in the near term, we believe that the direction of pricing appears favorable and that high yield fundamentals, including relatively benign default rates and a likely continuation of the credit cycle, remain intact.

Emerging Markets Debt

EMD fundamentals generally remain under pressure due to slow growth, exposure to the commodity downturn in many cases, and uncertainty about China's financial and structural reform efforts. We believe weak domestic demand is likely to keep a lid on emerging markets growth over the next 12 months. Lower commodity prices hurt producer economies and the strong service-sector orientation of the recovery in developed markets is impairing the growth pass-through to emerging markets. Despite these near-term risks, a recent widening in yields could allow for relatively attractive returns on a 12-month horizon for both hard and local currency bonds. We currently prefer sovereign bonds to corporate bonds due to more favorable valuations while corporates suffer from weak growth and low commodity prices, combined with constraints on access to funding. We continue to see value in local bonds but our appetite is restrained by continued pressures on EM currencies.

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