Co-Heads of Investments Ben Kirby and Jeff Klingelhofer discuss opportunities on the front end of the curve, economic surprises, and threats.
Observations: Relative Value, Resilience, Reaction and Risk
Adam Sparkman: So Jeff, based on your balance sheet comment, where is Thornburg finding the best relative values in fixed income, and how do you feel about taking risk in the portfolios given the current environment?
Jeff Klingelhofer: Look, I think overall, the starting place for fixed-income investors is better today than it has been over the last decade, decade and a half, right? Yields overall are higher. The benefit of that is there are some dislocations we’re seeing, right? We talked about the US consumer being one of the spots that remains incredibly, incredibly bright and we’re watching it closely, but a lot of those opportunities are on the front end of the curve and with an inverted curve that actually allows you the opportunity to one, get higher yield and two, not have to extend nearly as much into that higher volatility if and when the recession does come to fruition, right? So, we are focusing on US consumer, mostly securitized products on the front end of the curve. We see a lot of value there, more focused on the prime, very high-quality consumers, very good structural protections, and we’re also offsetting that on the longer end with some US agency mortgages, for instance, in treasuries, right? Things that we do think really will act as ballast if we get that recession either deeper or earlier than, than our expectations.
Adam Sparkman: So, Ben, maybe just broadening that a little bit. thinking back on the first half of the year, what’s been, been the biggest surprise to you with markets and then maybe looking forward to the second half of the year what, if anything, keeps you up at night?
Ben Kirby: Sure, so I’ll, I’ll answer a couple ways. one is just the resilience of the US economy has been surprising, but a lot of that is not that the level of the US economy is so strong, it really is that expectations were very low going into the start of the year. So economic surprises on a, on a broad brush, have been positive for the US, pretty much all year long. So stepping over a low bar is enough to make risk assets go up. The other big surprise, I think, has been home prices have gone up, so that was not something we expected early in the year. I think a lot of it has to do with 75 percent of borrowers have a mortgage at less than 4 percent and they just don’t want to move because that’s an asset, and so that’s creating a supply constraint, which is causing prices to reaccelerate, even though mortgages are high and affordability is relatively poor.
Adam Sparkman: How about for looking forward to the, the second half of the year? What keeps you up at night?
Ben Kirby: I think it continues to be geopolitical concern and risk, I mean, whether it’s, um escalation in Russia, Ukraine, or is something happening between the US, Taiwan and, and, and China? There’s just a lot of potential hotspots that could flare up.
Adam Sparkman: Okay. Jeff, same, same questions for you?
Jeff Klingelhofer: Gosh, what surprised me, I mean, I’d have to agree with Ben, just the resilience of the economy, but overall, I think it’s also the Fed reaction function in response to the resilience of that e economy, right? Really, they’re having to throw an entirely different playbook and it’s because the underlying fundamentals have become entirely different than what we’ve, we’ve had in the past, right? With inflation now overshooting, rather than undershooting consistently, and as I look forward to the future, I think it’s, the biggest challenge investors will face and what keeps me up at night, really as a fixed-income investor, is I think that playbook may have been fundamentally altered. Even as we do eventually have that recession, I worry the Fed won’t be nearly as willing to cut rates to, to, to squash the downside, and I think that’s not just true of the US. I think that’s true of central banks around the world, that we’re having to re-learn what it is to live in a inflationary environment rather than a deflationary environment.
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