Active Fixed Income Investing in a Complex Global Environment

David Rolley:
As we look around the world, one of the opportunities that we particularly like is emerging market local currency government debt.

We've done a number of things. In the US treasury market, we've had a tendency to sell into the rally as we've been flirting with a 4% treasury. We've been reducing duration in the United States. In other markets, we've done some other things. We became very alarmed at French politics and reduced France very early in the year, and I think we just lost another prime minister as we speak. It's just the problem is that France tends to have some form on gaudian demonstrations, and so we thought that this is going to be very difficult and the market would be disconcerted by that.

Let me mention one last thing where we've added some duration, and that's in Japan. The 30-year government bond has gone over 3% in Japan. Again, now we have a new prime minister. We've taken advantage of plus 3% yields to actually add 30-year GBs for the first time that I can remember.

One of the opportunities that we particularly like is emerging market local currency government debt. The reason for that isn't just the yield advantage. It is that it is a consequence of this changing global trade policy. China, and to a degree the other Asian exporters as well, have had to divert exports away from the United States to other countries. Many of those countries are other emerging markets. Well, they're exporting disinflation to those countries. That means that the inflation outlook is better than it would be otherwise. In that world, you can look for policy interest rate cuts, and you can look for curve flattening. If you buy duration in those markets, you're likely to do rather well.

Well, if you think about it, the 1970s, we started with an overvalued currency. We changed the rules. And then we had trouble funding our deficits, and then we had a supply shock. Basically, everything went wrong. When you think about inflation, inflation really takes two forms. There is what you might call fiscal inflation, and that's where a government prints money to pay its bills. Think Argentina. For 100 years, think Venezuela. We're not there. We're not there in the OECD, not even in the United States, so we can set that aside for now.

There's another kind of inflation, and that's when there was a shock to supplies. If you think about the COVID inflation, that was a supply shock as well as an over stimulus. Going back to the '70s, oil prices were part of that story. It wasn't just a weak dollar. It wasn't just excess money printing. There were also oil shocks involved as well. Right now, if you look across the world, the oil market looks benign. The temperate food grain markets look benign. The only real place that we see inflation pressures is actually in the price of electricity because of the demand for hyperscale servers.

I am a fan of Charles Kindleberger's theories of hegemonic reserve currency dominance. In this case, we've had a hegemon in place who has either resigned or gone on Sabbatical or something. Anyway, the rules are going to be different, but those rules were in place since 1945. That's the entire history experience investors have lived with. We may be in the process of coming up with a new global social contract for trade, for currencies, for capital flows. That contract isn't written yet, and we're in a kind of what you might call a discovery or construction process. Well, that's tremendously uncertain.