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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
Welcome to the TCW Investment Perspectives Podcast.
I'm Anisha Goodly, Managing Director and Co-Head of
the Fixed Income Portfolio Specialist Team at TCW.
Today we're turning our focus to the Middle East, a region
at the center of some of the most consequential geopolitical
and macroeconomic developments facing investors.
The ongoing conflict is influencing global growth expectations,
risk sentiment, and capital flows, with important implications for
fixed income markets across both developed and emerging economies.
To help unpack these dynamics, I'm joined by two of TCW's
most experienced voices on global and emerging markets.
Ruben Hovhannisyan is a Generalist Portfolio Manager in TCW's Fixed Income
Group, where he helps oversee more than $170 billion in assets and
brings deep expertise across global rates, credit, and macroeconomics.
David Robbins is a Group Managing Director and Head of TCW's Emerging
Markets Group, with more than four decades of experience navigating
emerging markets cycles, geopolitical risk, and sovereign credit markets.
Ruben, Dave, thank you so much for joining us today.
Thanks for having us.
Anisha, thanks for having us.
Of course.
Ruben, let's start with you.
To set the stage, we're about two and a half weeks into this conflict.
We've seen a spike in oil, a notable backup in rates.
What's your take on the market response thus far?
Great question.
So I'd say market reaction thus far has been
somewhat mixed across different markets.
On one hand, you have rates market that has seen a very sharp repricing
across the globe, really, driven by a spike in inflationary expectations.
And that in turn is consistent with sort of an extended war scenario where
you have persistent inflation elevated for a certain period of time.
In the US, we've seen the front end of the yield curve.
We've seen an almost parallel shift, but driven mainly by the front end.
The two-year part of the curve is about 40 base points higher,
and that's mainly driven by break-even inflation expectations.
And if you look at the Fed funds market, we were pricing
in slightly over two cuts earlier this year, and now
we're pricing in only, you know, almost half a cut.
And the first full cut is being priced in sometime in summer of 2027.
So pretty significant repricing there.
And if you look at other developed markets, in Europe, for
example, UK has seen a lot of volatility and very sharp repricing.
Eurozone and UK were actually pricing in modest cuts earlier
this year, and they're both pricing in rate hikes now.
Again, pretty significant repricing in the rates market.
On the other hand, when you look at the credit market or equity
market, so equity market is down 2.5% on the year-to-date basis.
And by the way, from pretty frothy valuations, arguably, at the end of the year.
And if you look at credit markets credit, IG
credit has widened about five basis points only.
And that's despite all this volatility in the backdrop
and huge glut of issuance that we saw last week.
High yield is wider about 20 basis points.
So they are wider, but the widening has been marginal and very modest
compared to the sharp, violent repricing that we've seen in the rates market.
So that's sort of the inconsistency because that very mild, modest
widening in the spread market is suggestive of sort of more benign
inflation elevation, both in terms of duration and magnitude.
Because if you were to expect the inflation to be elevated for a, you know,
persistently elevated for a period of time, which is sort of embedded in rates
market pricing, then you would also expect some real demand destruction, lower
corporate profits, higher leverage ratios, and much wider
spreads as well, which is not what we're seeing now.
Now, obviously, to be fair, one area of credit that has seen
more pronounced widening is Middle East and EM in general.
So sort of markets that are in the eye of the storm and markets that
are more disproportionately exposed to the supply chain disruptions.
So these are markets that Dave Robinson team are monitoring very
closely, and I'm sure he has very interesting insights to share with us.
Ruben, you brought up some really important
points, and that's a great transition into Dave.
Dave, we've clearly seen the conflict escalate.
Tell us a little bit about the market reaction in the Middle East specifically.
And importantly, where do you think things go
from here, the scope, duration of this conflict?
Well, you know, obviously, so much depends on the duration of the conflict.
But I would say within the region itself, Middle East
spreads, which are generally a higher quality portion
of our market, it's predominantly investment grade.
Many AA and single A credits have widened out 30 basis
points in this environment, which is a significant
amount for higher quality credits in our market.
Now, high yield credits, particularly oil importers,
have widened out as much as 100 basis points.
I think, you know, from our perspective, what we're seeing
right now is a continued escalation of the conflict.
Oil assets were initially not being targeted.
So again, you know, we continue to see escalation on both sides.
Now, you know, Trump's strategy has been to escalate to negotiate.
So we may be hitting a point where there is a process to unwind this.
And all we know right now is that what's happened is they've restricted
transport through the Straits of Hormuz, which is obviously the
vehicle where most of the GCC exports its oil predominantly to Asia.
So 20 to 25 percent of seaborne oil comes through the Straits of Hormuz.
And that has virtually stopped for many GCC countries.
There are pipelines in Saudi, the east-west pipeline.
There's pipelines in the UAE, which can get back some of that oil, but only
about 7 million barrels per day at the max vis-a-vis the 20 million barrels per
day that they're theoretically losing from shutting down the Straits of Hormuz.
Now, Iran's strategy is really one of survival.
Their ability to create a dysfunction within the global supply chain
and with higher oil prices globally is their effort to really get
the world to step back and hopefully come to the negotiating table.
And Dave, let me pick up on that.
What are you watching for that leads to stabilization, right?
You're talking about the escalation to de-escalation.
What do you think gets us there?
Look, you know, clearly Trump has talked about a limited timeframe for this war.
And as long as it's a limited timeframe, I
think, you know, the market can survive.
So I think the market has been less of a desire to really get too
negative because the view is that Trump reacts to market signals.
At the same time, you know, it's unclear whether the U.S.
goals, vis-a-vis the Israeli goals, are similar.
Clearly, there's a desire for regime change on the Israeli side.
I think the ability to institute regime change from the air is a very
difficult process and has never really been successful throughout history.
So I think the fact that they've been able to neuter, to a large extent, their
ballistic missile program, decrease their drone production, and decrease their
drone attacks, I mean, you know, that will
be viewed to some extent as a success.
So Trump can walk away any time from this claiming a victory.
But the key will be to get the Straits of Hormuz running again, because
that is really the choke point right now in the global economy.
And it's not only affecting just crude
production, but it affects a lot of products.
It affects fertilizers, you know, which is very
important for countries like India and Asia.
It affects petrochemicals.
It affects aluminum.
So there are a lot of other markets and a lot of other supply
chains that are going to need to be reconfigured in this process.
And then the question is: how does it affect
the long-term perception of the region?
Obviously, the UAE, Dubai, Saudi Arabia were really promoting
a broadening out beyond oil and gas, focusing on tourism.
If the region is not perceived as safe as it was before,
clearly that's going to put a dent in that diversification.
And that diversification strategy.
And I think in general, it's going to put a
higher premium on oil prices going forward.
I mean, starting this year, most people expected with the
excess supply in oil, for oil to be in the $50 to $60 range.
I wouldn't be surprised that if oil settles in
the $70 to $80 range, even after this event.
So Dave brought up a number of really important scenarios.
Ruben, when you're looking across the global fixed income
portfolios, tell us about what you're thinking through.
What are some of the most important investment implications in your view?
The key variable in evaluating investment implications
is, as Dave alluded to, is the duration of the conflict.
If this ends up being a relatively short-lived conflict, then
you could make the case that the impact on inflation, on core
inflation at least, and on growth will be relatively benign.
If, on the other hand, this ends up being a long war, an
extended war, then we will see inflation that's more persistent.
We will see inflation that spills over to non-energy segments.
Dave mentions fertilizers, but there's also chemicals, plastics,
and fertilizers will also have implications for food inflation.
It's still anecdotal at this point, but we're already
hearing about some industries that are just weeks away
from running dangerously low on feedstock and gas.
So if this war extends for months, we'll certainly see more
inflation pressures outside of the direct impact of energy prices.
The other impact that we'll see if the war drags on and ends
up being an extended war is obviously an impact on growth.
This may come a little later.
The initial impact will be inflationary shock.
But if this persists, you are going to see destruction of
real aggregate demand because consumers will have less
real discretionary impact to spend on goods and services.
So that will result in contraction of real aggregate demand, and that will have
consequences, obviously, for corporate profits and economic growth in general.
And let's dive into that a little bit further.
How are you thinking about current positioning through
these lenses of inflation and rates volatility, et cetera?
We think that, as I mentioned, credit markets haven't reacted in any significant
manner outside of some isolated, not isolated, but outside of EM and countries
that are disproportionately exposed to the conflict in supply chains.
But the rates market have reacted very sharply.
And we think that the reaction in the rate market may be overdone here.
Of course, extended war scenario cannot be ruled out.
It's possible.
But it seems like the market may be extrapolating
from 2022 Ukraine invasion experience.
And we would agree that there are some similarities, but we
would also argue that there are very important differences.
And the first important difference is that in 2022, the U.S.
households were still...
We were in a very significant fiscal expansion phase.
So U.S.
households, a lot of them at least, were
getting monthly checks from the government.
And that was certainly stimulating the discretionary income and
spending exactly at the time when we were being hit by a supply shock.
So you had a classic situation of too much money chasing too few goods.
And that led to an inflationary experience that we experienced in 2022.
The other important difference is the labor market.
We all know that 2022 was a unique environment where, despite being
in the recovery phase and coming out of COVID-induced recession, the
labor markets were very, very tight, especially labor supply markets.
So that led to an environment where employees were able
to go back to their employers and ask for higher wages.
And given the tightness of labor supply, they
were able to get the higher wages in most cases.
And then higher prices begot higher wages, higher
wages begot higher prices, and so on and so forth.
But the key link there for that transmission mechanism is labor market.
And the labor market today is very different from labor market in 2022.
We would argue that labor market is weak and has
been weakening, so that important link is not there.
So, all else being equal, we think the dynamics of 2022 and today
are very different, just based on the two observations I just made.
And hence, we think the market may be...
the market repricing may be overdone here because it's at least
partly extrapolated from 2022 experience and recency bias.
But we're in a different environment now.
So, given that, we have added some duration here in the front end of
the curve, in the front end of the UK curve, which we thought was, you
know, one of the more attractive opportunities in the rates market.
And that's sort of consistent with our view of the rate market repricing.
So, taking advantage of some of the moves that
we're seeing in terms of this volatility.
Precisely.
Dave, how about you?
How are you navigating the EM debt portfolios,
both from a credit and a currency perspective?
Well, we've been able to outperform in this environment because we've
been long a lot of the credits that benefit from higher oil prices.
So, a lot of our overweights are in oil exporters.
And as a result, those have outperformed.
And a lot of our underweights are in oil importers.
And so, structuring the portfolio in that way, we've also been underweight
in the Middle East, and we've been slowly, as spreads widening,
looking to cover that underweight as spreads continue to widen out.
So, structuring the portfolio in that way has enabled us to outperform
some of the best performing credits this year have been, you know,
Venezuela, Gabon, Angola, Colombia has also been a strong performer.
On the other hand, some of the worst performers have
been Egypt, Sri Lanka, Turkey, you know, and some of the
local currency markets have been significantly impacted.
In fact, I would say that the local currency market has been
more significantly impacted than the hard currency market.
You know, your local currency market is down about 4% this month.
And we think once you get stabilization in this conflict,
there will be a time to slowly add to the portfolio.
And, you know, we've been looking at, as spreads
widen out, incrementally add risk at certain points.
And I think we'll continue to do that.
Again, we think this is probably another, you know, week to two weeks at least.
So there'll be ample time to take advantage of dislocations.
We think ultimately this is not sustainable politically
for Trump, particularly with the midterm election.
With the midterm elections coming up, he's
going to continue to get a lot of pushback.
And there is some dissension within the base in terms of this strategy itself.
We think it's more likely that Trump is incentivized
to make this a shorter conflict than a longer one.
And as a result, we think once this starts to subside, that will
be an indication to get more aggressive in terms of adding risk.
Thanks, Dave.
And Ruben, is there anything else you want to add to that in
terms of risk positioning or rotations within fixed income?
Well, this is an environment where we think
selectively adding risk is appropriate.
And we've been doing that as value investors.
So I already mentioned the rate trade.
We added some front-end duration on significant repricing in rates.
We've also added some high-quality investment grade
Middle Eastern names, the names that Dave alluded to.
These are 20, 30 basis points wider.
These are high-quality investment grade sovereigns and quasi-sovereigns
that are 20, 30 basis points wider than they were three weeks ago.
And so we thought those are attractive opportunities as well.
We took advantage of some investment grade new issues in the
US that came with very meaningful new issue concessions.
And we also added a select basket of currencies
that we thought were oversold in global accounts.
That's all the time we have today.
Thank you Ruben and Dave for sharing your insight today and really framing
the developments in the Middle East and what they mean for global investors.
Thank you all for listening to the TCW Investment Perspectives podcast.
We look forward to continuing the conversation as we explore
additional trends and opportunities shaping global markets.
Thank you for joining us today on TCW Investment Insights.
For more insights from TCW, please visit tcw.com/insights.
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