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For today’s soundbites, we discuss sovereign bonds with Anujeet Sareen, portfolio manager with Brandywine Global Investment Management. He talks about where he finds value, why he likes some emerging market bonds. And we started by asking what he sees in recent interest-rate moves.

Anujeet Sareen (AS): Interest rates are macro assets. What that means is that when interest rates rise or fall enough, they impact the economy. At the peak of the cycle, when rates are going up, at some point they are a headwind to credit growth, a headwind to housing, and economic activity slows at that stage. Ultimately that leads to lower inflation. It leads to an easing by the central bank and a decline in interest rates. And the same thing holds on the other side. At some stage, interest rates fall far enough that they elicit a reaction in the private sector, housing tends to pick up, business investment will pick up, inflation will start to firm, and the central bank will often start to withdraw monetary stimulus as well, and hence interest rates will rise. That dynamic, we saw it play out quite dramatically, in a somewhat compressed time period from the fall of last year into the spring of this year. Interest rates had fallen because of the pandemic-induced recession that we had last year. We had this tremendous amount of policy support, economic activity started to improve, housing and durable goods spending boomed, and ultimately, inflation picked up during that period. And we saw then the opposite reaction. Interest rates had collapsed in the first half of last year, they started to rise in the fall and winter, and then rose more visibly into the spring of this year, as that whole dynamic played itself out.

How the current market is different from the great recession.

AS: One of the biggest differences today is that the banking system is in terrific shape. And that means that the banking system can pick up the baton from what the central banks have been doing to provide monetary support. They’re going to make loans over the coming year that’s going to sustain an economic expansion and that’s a reason to think, again, that the interest rates are more likely to rise from here as credit demand improves.

What sovereign bonds he likes, and which he’s avoiding right now.

AS: The bond markets that we’re avoiding really are the higher quality government bond markets that you are mostly looking to hold during times of economic stress. We’re not in that kind of a period anymore. And, also, as the banking system revs up and starts to provide more lending, the attractiveness, we think, of government bonds in Canada, and the U.S. is likely to diminish. And so, at this stage, we would avoid exposure to those markets.

On the other side of that, I am still going to turn to emerging markets, particularly in countries like South Africa and Mexico. But let me focus on South Africa for the moment. South Africa is a country that’s had a very stable inflation performance for a number of years now, where inflation has been close to 4%. You have 30-year bonds in South Africa that are closer to 10.5 or 11%. That is a lot of excess yield above the run-rate of inflation. So, that’s a bond market that we think is really worth considering.

Finally, what’s the state of corporate bonds?

AS: We’re coming off a year and a half where bond markets have done, or certainly until the beginning of this year. And the opportunities that presented themselves last year have diminished. So, the opportunities that we think remain are in the sector of the market that has been given the least amount of support. So, if you think about all the policy steps that were taken this past year-and-a-half, they were led by developed-market central banks and developed-market politicians to provide support for their own companies and individuals. The emerging markets just have far less resources to do this. And so, their recoveries have been more uneven and have been slower. And asset markets are reflecting that. When we look forward though, we think a normalization of activity is likely in these countries. They, in many cases, have already started to take back some of the fiscal stimulus that was provided last year, as opposed to the U.S., for example, that has continued to add even more to the debt of the United States government. So, countries like South Africa, Mexico, and other select emerging markets we think are still worth considering.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Anujeet Sareen with Brandywine Global Investment Management.

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