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00:00Golden age for fixed income, that's quite a big assertion, and you say it's mainly because of the broad opportunities,
00:06not just in treasuries, not just the U.S., but in other markets as well.
00:09Exactly, and thanks for having me on the show, Husslinder.
00:12I'd say, you know, we've been calling it a golden age of fixed income, but I'd say it's actually probably
00:16the golden age of investing.
00:18Whether you're in the U.S., Europe, Asia, whether you're looking at fixed income or equities, there is something to
00:23do.
00:24It's one of the most exciting times to be an investor, at least in my career.
00:27But in fixed income specifically, I think the golden age refers to this unique opportunity to build an income stream
00:34that's higher than it has been historically for much lower volatility.
00:39For a 6% income stream, which is pretty high by most people's standards, you only have to take about
00:442% to 3% volatility.
00:46You don't have to reach out the curve like you used to.
00:49There's been risks around the long end of the curve, and you don't have to reach down the credit quality
00:54spectrum.
00:54We've even seen jitters in the lower part of the credit spectrum lately.
00:58This is the unique opportunity that we think people should be locked in for the next 1 to 3 years.
01:03You talk about the risk on the long end of the curve.
01:05We have the tariff wobbles.
01:08How do you see that shaking out at a time where defence spending, as Trump outlined in SOTU,
01:14that could also be another issue when we look into next year?
01:17I think the fiscal trajectory in the US is probably one of the biggest risks for fixed income investors,
01:24although that seems to have been more contained than what the worst fears were.
01:29You know, 6% fiscal deficit indefinitely.
01:32We're seeing about $2 trillion of supply net per year,
01:35but that works out to about $500 to $600 billion of gross supply of treasuries per week.
01:41To put that in perspective, that is the size of the entire Australian government bond market.
01:45But imagine if Australia, or Singapore for that matter,
01:48tried to roll their entire government bond market every week.
01:52I think that's a part of the market that's vulnerable and that is underappreciated.
01:57But at the moment, there is demand for 3.5%.
02:00But fiscal risk is a huge issue, right?
02:02And it's not just about the US.
02:03It's Japan and some other countries as well.
02:06If the US can do it, so can we.
02:07And I think that is the general consensus among governments.
02:10Yep, I think it's a valid concern.
02:12And that's why we think the optimal fixed income portfolio should not be oriented at the long end.
02:17Something like the front to belly of the curve offers ample yield with much less volatility
02:22than what we've seen at the long end.
02:24Japan, for example, last month yields at the long end blowing out.
02:28You know, those dislocations are actually, interestingly, opportunities to add.
02:32But I think, you know, those are opportunistic trades rather than to build an entire portfolio around.
02:37How are you seeing the extent and conviction among investors, though?
02:42Because there's this idea that for us to go big into JGBs, the BOJ needs to hike.
02:48And then now you have two nominees that look a bit dovish.
02:51Well, I think there are parts of the JGB market that kind of balance all those factors.
02:56Yes, the front end is quite low in yield.
02:59And so that means the curve is steep.
03:01As you get longer, when you hedge those yields back to dollars,
03:04that actually fits nicely in a 6% yielding portfolio.
03:07You can get up to 3% to 4% on the JGB yield itself and another 2% pickup
03:11in the FX hedge.
03:14But again, I think the longer you go out the duration spectrum,
03:17the smaller you can be in terms of size so that you can control for that volatility.
03:21So this will be coming in spite of whether we see BOJ hikes, you think?
03:25I think the BOJ hikes will help to flatten the curve.
03:28And so the long end is more resilient.
03:32If that's anybody's guess.
03:34What's your guess?
03:35I think that the BOJ can probably continue on its hiking cycle.
03:39But it will want to be patient because Japan, let's face it, it has faced decades of deflation.
03:45It's just now coming out.
03:47When I was in Japan recently, I think people were genuinely surprised and curious about how
03:53to deal with inflation, looking at menu prices of their favorite restaurants,
03:57where prices have changed for the first time in decades.
04:00This wage price, they call it a spiral, but really it's just a relationship.
04:05Wage price relationship is just starting to get going.
04:08The BOJ wants to ensure that it's properly nurtured.
04:11I think they are probably a little behind the curve and can afford to hike,
04:15but they are deliberately behind the curve.
04:17So, you know, I think they may continue to ensure that this relationship holds.
04:22Has it been surprising that JGBs have been pretty steady after that volatility in January?
04:28And are you confident such volatility that we saw will not return?
04:32I think that kind of volatility is pretty unique.
04:35And actually, we seize on that kind of volatility to buy dislocated assets.
04:40I'd be surprised if that degree of volatility returned.
04:43But at the end of the day, the underlying forces that created that haven't changed that much.
04:49I think many people are waiting for pensions,
04:51which are the main source of demand for long-end JGBs, to come back into the market.
04:56And on the supply side, people, I think, are waiting for some clarity around the fiscal program.
05:01But again, these are risks we've talked about.
05:04What about markets such as Australia?
05:06I mean, I was just mentioning earlier about how perhaps investors see it
05:10as likely a bit less affected by the AI concerns.
05:15Is that part of, you know, why you would dip into a market like that,
05:19given the yields at these levels?
05:20Absolutely.
05:21So, Australia is one of the few markets that's pricing in hikes.
05:24So, let me just remind you, U.S. is pricing in maybe 50 to 60 basis points of cuts.
05:29Australia pricing in 30, 40 basis points of hikes.
05:32So, that's about a 100 basis point differential in the forward curves.
05:36That's a very attractive yield for fixed income investors.
05:38And the fact that we've now identified assets in the U.S., Japan, and Australia
05:43to go into roughly a 6% yielding portfolio,
05:45that just goes to show how attractive the global opportunity set is.
05:49So, in Australia, if you add a little bit of spread,
05:52I'm talking high-quality spread, investment grade,
05:54you end up back into that 6% yielding range,
05:57which I think is a very complementary asset to add.
05:59Are there specific sectors you're looking at for Australia?
06:03Well, in Australia, the banks tend to be the most,
06:05the bulk of the credit market.
06:06But really, it's not just banks, but you're also counting on term premium.
06:12So, it's the risk-free part of the curve that's also attractive, government bonds.
06:16And I mean, we've been talking about the AI scare.
06:18Is that part of the reason why fixed income is the way to go?
06:23I mean, do you hedge?
06:24So, you call it the AI scare.
06:27I'll call it the AI economic transformation.
06:31And I think the market is trying to deal with this economic transformation.
06:38It's pretty unprecedented, unless you go back to the times of the Industrial Revolution,
06:43where you've got, you know, inflation, I'd say, was yesterday's news,
06:47and labour is tomorrow's problem.
06:50You've got a large-scale fiscal programme.
06:54You're coming off the back of a large-scale fiscal programme, and that's being met.
06:57That's been inflationary.
06:58And that's being met by, you know, if you go back to Econ 101,
07:02labour is now less of a constraint to output.
07:05That's extremely disinflationary.
07:07So, you're coming off an inflationary force.
07:09You're seeing a disinflationary force in the future.
07:12And I think the market is trying to grapple with how to weight those two things.
07:16And I think we're still underappreciating how disinflationary that, you know,
07:21transformation could be, as evidenced by the fact that forward curves are not pricing in much cuts.
07:27We want to talk also about Fed policy.
07:30We are watching out for what happens in the back half when Walsh comes in,
07:34I mean, in May, when he takes over, right?
07:37But his intention seems to be a smaller balance sheet.
07:40What is that going to look like for the long end, exactly?
07:43So, when you say smaller balance sheet, I think there are two ways to think about it.
07:47One is in absolute dollar terms.
07:49The other way is relative terms.
07:51I think the easier way to shrink the US balance sheet is relative to nominal GDP.
07:56You grow your way out of the debt.
07:58I think growth will continue to run pretty hot.
08:013% rail, 3% to 4% rail.
08:03We've had two quarters of 4% rail.
08:06And about 2% to 3% inflation.
08:08That gets you to about 6% nominal growth.
08:11That's a pretty healthy nominal growth rate for the US.
08:15So, you talked about, I want to go back to what you said about this golden age where opportunities are
08:19broad.
08:21Europe, traditionally, the yields have been far lower than the US.
08:24Why is it as attractive as the US?
08:26Well, inflation in Europe is running lower.
08:29So, if you look at it on a rail yield basis, the rail yields in Europe aren't half bad.
08:35And I'd say that's true even in Asia.
08:37So, that's why it's the golden age.
08:39It's a geographically diverse, it's a global opportunity set where rail yields in aggregate and across the world are at
08:46about the 1% to 2% level,
08:48which is much higher than where they were just in the 2010s, when many rail yields were deeply negative.
08:54Japan continues to be one of the standouts as having a negative rail yield today.
08:58But the rest of the world is largely in this positive rail yield territory.
09:03And rail yields are the compensation or margin of safety for being wrong on inflation.
09:07So, to be able to bake in this rail yield buffer, and in Europe, if you swap it back to
09:11dollars, you get another 1% to 2% of pickup.
09:15That puts European assets squarely back into that 6% range of which we use as building blocks for an
09:22income stream.
09:24It sounds like there's a lot that you like out there.
09:27What do you not like?
09:28I mean, the front end of Japan is still quite low yielding.
09:32And there are parts of the investment grade market.
09:34I'd say very high-quality spread products, high-quality investment grade, that spreads are very tight.
09:39So, those, I'd say, are less attractive on a relative basis to pretty much any of the alternatives,
09:45whether it's cash, the Treasury itself, or high yield, which has a bigger spread buffer.
09:51Emerging markets, how are you looking at that?
09:53Absolutely.
09:53I think emerging markets have pretty much a lot of things going for it.
09:59There's policy uncertainty on the developed market side.
10:02There's a cash rate in DMS that's been coming down, I think, for a long time, two to three years
10:08now.
10:08The U.S. policy rate has acted as a magnet for cash.
10:12Money markets have been the biggest beneficiary.
10:14Now, as the cash rate starts to drop and has dropped to 175 bps, expected to drop further,
10:20this is acting as a catalyst for cash to seek higher-yielding investments.
10:24Some of those exist in emerging markets.
10:26It sounds like really the perfect time to be buying into fixed income, yet people still
10:31talk about 60-40.
10:3260-40.
10:33I mean, how do you revise that?
10:35Why aren't people thinking about 60-40, you know, fixed income to equities?
10:40Well, I think the 60-40 mantra of old, the 40%, people tended to associate it with duration.
10:49Duration has failed to be a hedge for equities.
10:52And so some people have called for the death of 60-40.
10:56I don't think it's the death of 60-40.
10:57I just think you've got to think about your income allocation differently.
11:01People are still going to invest in stocks.
11:03That's the right place for someone who's young to invest in, in the capital stack.
11:07Stocks have done very well.
11:08The best complement for an equity portfolio today, we think, is a steady and strong income
11:14stream with not a lot of duration.
11:15It's hard to think about steady income stream and 6% yields when you're in the stock market,
11:23you get double-digit growth.
11:25I think that is what people are grappling with.
11:27So we've had three consecutive years of that double-digit growth.
11:31And that has also, I think, acted as a deterrent to fixed income flows to some extent.
11:36But from today's starting point, when you have stock valuations where they are, and the
11:42ability to still construct a 6% carrying portfolio with arguably 2% of price appreciation, that's
11:49an 8% total return.
11:50And I think the right question one should be asking is, if your starting point is 8% in
11:55fixed income, what do you require equities to do in order to allocate down the capital
12:00stack?
12:00That answer is probably 10% to 12%.
12:02And we may get 10% to 12%.
12:04But I think it's a really fascinating debate.
12:06I think we also might want to touch on what we see in the credit wobbles.
12:11I mean, we've been seeing private credit, the AI concerns are reeling there, especially
12:16as investors grapple with the sort of software disruption that could affect industries.
12:22What is your sense of, is there any flow or ripple effect into fixed income?
12:27I think if the problem worsens, there will be.
12:30But let me just put some perspective on private credit.
12:34Most estimates have the private credit market at about 1.5 to maybe 1.8 trillion.
12:39That's a third the size of NVIDIA.
12:42NVIDIA's market cap is three times of that.
12:44So it's like a 30% correction in NVIDIA.
12:47That would be the size of the private credit market.
12:50Or call it a 2% to 3% down day in the S&P.
12:53That would also be about 1.5 trillion.
12:55So when you put it in that perspective, the size of the private credit market doesn't
13:00seem systemic.
13:02Now, I'd also say that I think a lot of things are getting lumped in private credit that aren't
13:06necessarily private credit per se.
13:09I think there is a large space between public and private credit.
13:13In future, we may not even use the terms public and private.
13:16I think there's just going to be credit.
13:18And really, it's about how you are underwriting that credit, not so much about whether it's
13:23public or private, which is how it's being underwritten.
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