Interest rate call: Still 'low for long'

Barring something unforeseen, global risk will remain tamped down
NOV 09, 2014
Mistaking today's environment for a normal cycle, investors have focused on rate increases when the real story is continued global economic weakness and persistent easy-money support. While the U.S. economy has mended and is growing, and larger emerging-market countries such as India and China are recovering, conditions in Europe and Japan have deteriorated significantly. Paradoxically, however, the unsynchronized and relatively weak nature of the global expansion should extend rather than curtail this cycle. The Federal Reserve will have no reason to embark on anything but a long and deliberate policy normalization process, with major pauses thrown in for effect and no surprises in store for the markets. In the post-taper world, other central banks (for example, the European Central Bank and Bank of Japan) will assume the Fed's mantle and continue to provide liquidity to the global economy. Barring something unforeseen —such as the European Central Bank's being spectacularly successful in avoiding deflation, or China's reviving growth through a policy stimulus — global interest risk will be low across the board.

NOT IMMUNE

The United States will not be immune. Our call has been low for long, and we are sticking to it. Scarcity of income will have investors paying up for income wherever they can find it. That is, until the seeds (likely characterized by tight monetary policy, a flattening yield curve, excessive valuations, and deteriorating macro and corporate fundamentals) of the next major credit event have been sowed. Highly favorable liquidity conditions and generally sound corporate fundamentals — in the form of moderate company issuer leverage and capital expenditure levels, high interest-expense coverage and well- pushed-out maturity profiles — remain supportive for credit-sensitive assets. For example, while absolute yields are less alluring, high-yield- bond and senior-loan spreads have widened, making them more attractive. For investors wary of a potential retracement of this year's rate rally, the floating-rate coupons of senior loans carry little interest rate risk. Within the investment-grade space, corporate debt and other credit-linked sectors — such as asset-backed, commercial-mortgage, and nonagency mortgage securities — are enticing. These securitized products are being supported by stronger underwriting standards and, we believe, are priced appropriately from a risk perspective. They offer investors the potential for attractive yields in excess of current Treasury rates. Diversified exposure to these sectors not only offers investors incremental income potential but may also serve as a broader portfolio's “ballast,” or potentially hold value in volatile markets. Krishna Memani is chief investment officer and Peter Strzalkowski a portfolio manager at OppenheimerFunds.

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