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While the US may be on the verge of emerging from financial repression , we believe much of the rest of the developed world is likely to remain in that dynamic for some time to come, largely to allow for continued delivering. The rise in real rates globally reflects some degree of economic normalization, with solid US growth, Europe emerging from recession, and reduced chance of hard landing in China, but emerging markets growth has been decelerating. Monetary policy normalization in the Rezone and Japan is likely to run well behind that in the
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US, which allows for holding some rate risk in those regions, such as selected peripheral exposures in Europe. In the US, securities assets look reasonably priced relative to their histories. Furthermore, for the higher quality and liquid segments of a portfolio, mortgage backed securities are providing a significant yield pick up relative to investment grade corporate issues, and the possibility that Fed CEQ tapering focuses more on Treasuries than on MBPS, as recent research suggests it should to maximize policy effectiveness, may argue for continuing purport of that market.
Emerging market debt has obviously been beset by significant total return losses and capital outflows, which may continue, but we would caution against painting the sector with an overly broad brush. Opportunities here are now presenting themselves, particularly in countries that don’t suffer from significant current account deficits. Also, while some market commentators have drawn comparisons to the 1997 currency crisis in Asia, we think such an analogy is greatly overdone.
Foreign exchange reserve levels, aggregate debt levels, and lattice stability, among other factors, are all dramatically stronger today than when Asian economies fell into crisis a bit over 15 years ago (see Figure 4). Thus, we see ME debt opportunities and risks as bifurcated across regions, and while there are certain areas to avoid, others will provide idiosyncratic opportunity. In the end, flexibility and opportunism are the watchwords for fixed income in the year ahead, as markets adjust rapidly to changes in economic prospects, monetary policy, and secular dynamics that promise to play out differently in various parts of the world .