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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.
The recent election of President Trump and the red wave of GOP victories
across the House and Senate have reinforced the dominant market
narrative of robust growth, higher inflation and a more cautious Fed.
However, it wasn't that long ago when markets were overwhelmingly
expecting emergency rate cuts to backstop a slowing economy.
Have things changed that much or is this just wishful thinking on the
part of markets at an uncertain inflection point in the current cycle?
Welcome to Focus on Fixed Income on the TCW Investment Perspectives Podcast.
I'm David Vick, head of TCW's Fixed Income Portfolio Specialist team, and
today I'm joined by Jerry Cudzil, Generalist Portfolio Manager, and Jeff
Katz, Securitized Portfolio Specialist and ETF Investment Specialist.
Jerry, Jeff, thanks for being here.
And let's jump right in.
Jerry, I'll start with you.
And let's just take a step back and look at the bigger picture.
Can you kind of take us through our general market outlook
and how it differs maybe from the sort of the current
sort of dominant narrative in the market out there?
Sure, Dave.
Appreciate being on here.
Maybe we could take a step back and level set, but we also have to
recognize that there's been some new information clearly in the
marketplace and the marketplace has written a new narrative.
Our view continues to be that we're seeing some trends in the labor market
and we're seeing the labor market continue to show signs of slowing.
And we see that in the most recent non-farm payrolls print.
Clearly it was impacted by some storms.
We see that in the jolts rate.
We see that in quits rate.
And so as we look at the marketplace, we still believe
that we are on a trend with a slowing labor market.
We would be remiss if we didn't recognize
obviously some of the most recent developments.
We'll get into that a little bit.
But what we would say, there's new information with the
president, the president elect that might introduce some
us to rethink or potentially reconsider our position.
But what we would say is the markets have a long history of electing presidents
and the president sits on top of a very complex system, a very complex economy.
Oftentimes the economy happens while the president is on top
and trying to affect change and trying to affect policy.
Ultimately the president can only do so much.
I'm hopeful that we'll talk a little bit more about some of the
policies, some of the impacts and then level set with levels also.
Great.
So let's, given that outlook, if we do expect that the labor market is in fact
slowing down, let's talk about how we're positioned across different strategies.
Maybe you start with a rates standpoint.
Sure.
So today we are, we're long duration across our portfolios.
We do believe that the Fed remains in restrictive territory.
And there's been some recent commentary around the Fed around
just emphasizing the fact that they're data dependent.
That's always been the case.
And I think we've had a couple of inflation prints that
have basically rewritten the narrative a little bit.
This year we've written about three narratives where we write a narrative
to inform and reflect the price action, very reflexive behavior.
And I think we're in that environment again today where rates have backed
up about 80 basis points as we've expected Donald Trump to be elected.
As we look back to 2016, you think about where
we were in 2016 and what has taken place.
Back in 2016, when Donald Trump was elected, we had a very
similar move in the tenure note about an 80 basis point move.
We've already priced all of that in.
So what we've done is I think in our interpretation, we've taken
out this kind of contested election volatility, but we've totally
ignored the policy implementation volatility and maybe some of the
offsetting factors of some of the policy implementation as well.
And so I think clearly as we lay it out, deregulation is a positive.
Deregulation in banking and energy, that's a positive.
Tariffs potentially have a negative impact, might be inflationary.
Immigration might prove to be inflationary as well,
along with some tax policy and extension of the TCGA.
But when you take a step back and look at 2016 experience, the last four
years of Donald Trump's presidency, inflation never ticked above 2.2%.
As a matter of fact, when he came into office, it was 2.2%.
It ticked down to 2.1% from a CPI perspective, and we never got PCE above 2.
And that's really informing our view.
We have a negotiator as president.
We do believe that tariffs will be used as that, a negotiating tool.
But we also don't believe that the president will harm the economy prospectively
and will do whatever he can to sit on top of an economy that's slow.
So we believe rates are in restrictive territory.
We believe that the Fed will continue to reduce those, and the
labor market we believe is already showing signs of weakness.
And then if in fact we have some new information, if in
fact the labor market restrengthens or animal spirits
are stoked enough to reignite, we'll have to reconsider.
But at the moment, that's our view.
Great.
How about along the curve?
I know you mentioned your long duration.
How about where on the curve are we generally positioned?
What part of the curve do we like the best, I should say?
Sure.
As we expect the Fed to normalize, that policy we
believe is going to impact the front end of the curve.
So two-thirds, about three-quarters.
The majority of our exposure is in the front end
of the curve, two-year note, five-year note.
So five years and in.
We have a little bit of our exposure in 10-year.
A lot of that's picked up because we are
constructive on the agency mortgage basis.
And so what we're really doing is taking any kind of active empirical
duration in rates, we're expressing that within five years and in.
And then we're also, we have interest rate duration exposure that
we pick up because of our constructive outlook on the agency
mortgage basis and the agency mortgage sector wholly.
Great.
Well, that's a good segue.
Maybe Jeff, we'll turn to you.
Talk about the Securitize sector broadly, agency mortgages and
other parts of that sector broadly, that places the things we
like, maybe things that aren't looking so good these days.
Great.
Thanks for having me here today, Dave.
I think where we sit today, if we look back on expectations
for performance of Securitize throughout the course
of the year, we've certainly surprised to the upside.
I think we've seen broadly spreads tighten.
However, when you step back and look on a relative basis versus
things like investment grade corporate credit, I'd say we still look
relatively cheap for a comparable quality and comparable durations.
Perhaps I start with agency mortgages, which is our
highest conviction allocation broadly across portfolios.
The agency mortgage-backed securities
market is a very large, very liquid market.
However, it was very materially impacted from a spread
perspective as the Fed was hiking rates to take inflation down.
Resultantly, when you look at agency mortgages versus things like corporate
credit, where we sit today, it looks to us as if corporate credit
is certainly priced to perfection or to that soft landing.
However, when you look at agency mortgages, given they have no credit risk, if
you look at historical spread relations between agency mortgages and corporate
credit, as one would expect, you would expect to give a spread concession
or a yield concession to own agency mortgages
given they're guaranteed relative to credit.
Historically, that's been about 20 basis points of yield.
However, given the elevated level of rates, agency mortgages have actually
presented a unique opportunity, one of the likes of which I haven't
seen in the 30 years I've been in this business, where agency
mortgages trade about 70 basis points wide to corporate credit.
So you think about where we sit in the cycle, you think about the pricing that
goes into that, I think there's a very high likelihood if we do see either soft
landing or a potentially harder landing where the Fed is moderating rates,
front ends coming down, and that's all constructive for agency mortgages.
So we think there's a very good chance that
that spread relationship remediates over time.
- Yes, within agency mortgages, what part of the market we
like the best, where the coupon stack, what characteristics
that we're looking for in that part of the market?
- Sure, I think you bring up a very interesting and a
very unique point about the agency mortgage market today.
Given the pace and the level that the Fed has hiked rates and 525
basis points, we see a coupon stack that has 10 to 12 tradable coupons
ranging from the low of one and a half up to the high of 7% coupons.
There's a couple of different trade ideas within that coupon stack.
I think broadly, we differentiate ourselves from the market in that the market
has tended to buy into the soft landing narrative, thinking that rates may
not come down as fast or far as I believe we think
they could, and they've opted for the carry trade.
And so they're purchasing current production agency mortgages.
I think the concern there is in the event that we do see lower rates, again,
whether it's a soft landing or a harder landing, there's certainly a very
high probability that those borrowers that have taken out mortgages at, you
know, six, six and a half, 7% are very likely to refinance very quickly.
So that carry goes away in very short fashion.
We, on the other hand, have opted to purchase what
are known as belly coupons or lower discount coupons.
And so these are some of the lower coupons from 2020 and 2021.
However, we think that, you know, the total return
potential of these coupons are very, very attractive.
These durations have extended.
If there's any sort of reduction in rates, you will see,
you know, high single digits type returns from a very high
quality, very liquid asset that can be monetized very quickly.
Great.
So we talked a little bit about securitized.
Jeff, you kind of hit it relative to corporate credit.
So maybe talk, Jerry, maybe a little bit about positioning in corporate
credit, what we like, what we don't, you know, that sort of thing.
Sure.
Broadly, when you look at corporate credit,
it is sitting at heights of the century.
So for the last 25 years, investment grade corporate credit
has, it's, we're in the one, one percentile of, of spreads.
High yield credit, same.
We, we are the tightest we've been in the last, in the last 25 years.
Long duration credit has never been tighter, historic
even longer than, even longer than 25 years.
Investment grade credit today trades at a spread of 70 basis
points and high yield credit trades at a spread of 250
with double B spreads in, in a spread of about 150 over.
So we see, unfortunately, very little value in corporate credit.
We think prospective returns are really challenged in corporate credit.
When you start at these spreads, breakevens are poor, a
small amount of widening can eat through multiple years of
carry as you look across high yield in investment grade.
And when we think about allocating to a corporate
credit, well, credit's a mean reverting asset.
So averages on corporate credit historically are 135 basis
points, averages as you enter a recession are 150 basis points.
Any way you think about looking at corporate credit, it is, it is very tight.
So whether or not the economy slows down, whether or not we see, we
think that we're in a stable environment, unfortunately, allocations
to corporate credit are, remain challenged prospectively.
So we are underweight corporates in a pretty significant way.
We have a max underweight across the board.
We don't think now is the time to reach in credit risk.
We are finding, you know, pockets of opportunity, but unfortunately,
you know, as I mentioned, fewer, fewer and, and further between.
There's a few idiosyncratic names.
There's a allocation to leverage finance, which
is as small as it's been in quite some time.
We are taking advantages of opportunities in the bank loan segment because
of, you know, because of high front end yields and that's how our current
yield and carry, but broadly speaking, we're, we're, we're underweight.
All right.
Thanks.
So with all that in mind, let's talk a little bit about how clients
might want to think about opportunities that exist today and how best
to take advantage of them over their sort of short and longer terms.
So we'll start with maybe you talked about the likelihood for
rates to come down, you know, benefits of being longer duration.
We talked to a lot of clients who are still invested in cash and money market,
you know, investment type investments and you know, how might they want to think
about extending out and maybe capturing some of the benefit of that duration?
What are some things that they might want to think about as they do that?
I think, thanks Dave.
I think on the extension of duration side, you
know, there's some sector trades that you can do.
I think if you look at the securitized market again, with rates
pushing back, like they have over 2022 and 2023, we've seen a
pretty material extension in the agency mortgage durations.
So sector specific funds to securitize, you can pick up duration
relative to core core plus, or the actual ag benchmark.
And I would say even for those who maybe not, don't want to take on
interest rate duration, but maybe want to add some incremental yield.
There are other asset classes that you can
mitigate some of that, but also pick up income.
And that would be classes like the collateralized loan obligations.
So CLOs, which have shorter durations being given that their floating rate,
however, they've been around for two plus decades have been very durable
through some very trying times and relative to corporate credit, as Jerry
mentioned, being on the tighter side, even with the performances
here, they still trade about 50 to 60 basis points wide.
So you can pick up some, some healthy incremental income.
Yeah, I would just echo Jeff sentiment.
There's more opportunity on the securitized side.
We do like CLO liabilities.
We think those are attractive.
We think significant parts of CMBS market remain attractive,
especially at the top parts of the capital structure.
We do a lot of work, fundamentally asset by asset.
As you know, agency mortgages tend to offer a significant amount of value.
And then the few idiosyncratic names in investment grade.
We've said this before on the podcast, fixed income can finally be fixed income.
You can earn an attractive yield at the moment,
high quality assets are yielding above a 5%.
If you construct a portfolio with a little creativity, you can
yield approximately six and a half percent, and that's attractive.
And then you can also participate in a little bit of price appreciation.
If there's some risk off event or volatility and fixed income will rally in that
scenario, but it'd be the ballast that it's supposed to be in your portfolio.
Great.
Well, thanks, Jerry.
That's actually a good segue to my next question, which is going
to be with rates higher now, and actually, you know, fixed
income actually having a real income component these days.
If investors are investing for that income, what are
some of the things they might want to think about?
What can people do to maximize that potential income?
I think it's a great question to think about.
There's something for everybody in the market today.
If you're constructive on duration, long duration portfolios,
you can extend out, you can lean into pockets of the
securitized market that are fixed rate in nature.
You can buy agency mortgages, you can buy long duration credit.
We think there's probably more attractive ways to get that carry.
But even in a lot of those scenarios, you're going
to be able to yield, you know, kind of 5.5%.
In middle income, if you're not as constructive on duration, even if
you want to extend out a little bit, maybe you want to go three years,
there's strategies to invest across multiple fixed income sectors.
A lot of folks are gravitating toward this idea of income across fixed income.
And as you think about all the different segments of the marketplace
you can take advantage of, securitized, emerging markets, leveraged
loans, there's a lot of ways you can create attractive carry.
And if you're a zero duration buyer, well, you know, there's
a lot of floating rate product in the securitized land
and the bank loan market that look attractive as well.
And today those yields are very high because
of the stubbornly high front end rates.
Yeah, I think I would just add to Jerry's
point about some of the multi-sector funds.
I think if you look at those funds and the yield that they throw off and the
ability to diversify across sectors, whether it be investment grade or high
yield, and dampened volatility in portfolios is
certainly attractive to us where we sit today.
Got it.
So that leads to my last question, talking about diversification.
Yeah, obviously people buy fixed income to diversify their equity
exposure to provide some downside protection in their portfolios.
What other ways can people still think about how to diversify
their portfolios in parts of the fixed income markets?
Yeah, I was going to say on the securitized side, the securitized
universe is broadly underrepresented in broad benchmarks.
And so one good way to diversify your portfolios and have different drivers of
performance is to lean into securitized, whether it's commercial mortgages, as
Jerry mentioned, agency mortgage backed securities,
or even the asset backed securities market.
So I think broadly speaking, relative to broad core and core plus
portfolios, they're materially different drivers of performance.
And what I would just add is we've seen a
lot of opportunity across fixed income.
One area we haven't talked about is just non-dollar credit, European credit.
We've found some attractive opportunity across the pond, so to speak as well.
So when you think about fixed income, Dave, we've mentioned a lot of areas,
whether that's emerging markets, non-dollar corporates, credit, bank loans,
securitized, there's a lot of ways to diversify a portfolio,
get different exposures, a lot of ways to create solutions
for clients, income solutions for clients in this market.
Great.
Well, thank you both for your input.
Thanks everyone listening for tuning into another
edition of TCW's Focused on Fixed Income podcast.
I want to thank Jerry and Jeff for joining me and
sharing their insights into navigating the markets.
For more information on TCW strategies, please visit our website at tcw.com.
Thanks for listening, and we'll pick up next time exploring
the 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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