Commodities And Inflation Near The Top Of The Cycle 

Commodities And Inflation Near The Top Of The Cycle 

Last week I was fortunate enough to interview Fraser Lundie, Head of Fixed Income – Public Markets at Federated Hermes who was visiting Australia from the UK. He gave great insight to the global bond market, as well as expressing some contrarian views.

How do you see the Australian Fixed Income market and what do you think about it, as you invest from a global perspective?

It’s clearly not the US, but certainly very relevant and interesting with what drives it, in terms of the relationship with China and the commodities cycle, so it is in play.

What are your thoughts on central bank rate hikes and the impact on credit?

We think there is quite a lot of reasons why we might be near the top in terms of commodities and therefore inflation expectations. I appreciate that that’s not the consensus right now but we look at what’s going on in China and the policy around covid and think there is more growth shock than what people are pricing in.

We look at the Ukraine and Russia and it feels like its heading to an ugly stalemate and that that is probably bearish for commodities.

Also, the US dollar has been strong recently which suggests what the Fed has done already is starting to be felt.

For all those reasons combined, if we are at or near the top in commodities, then inflation expectations are also possibly close to peaking. Then finally, we might be at the end of this extremely high volatility range for interest rates and that would be the ultimate catalyst for credit to start meaningfully perform again.

In terms of a recession and how high rates might go, do you have any view on how high US and Australian interest rates might go?

To some extent the Fed and other central banks are attempting to be quite hard line with their language in the hope that some of that will do its job for it. Like Draghi in 2011 style. Let’s hope that works.

At this point, I’d suggest there are probably too many hikes priced into the US and that the Fed would hope that as well!

If there was to be some evidence of inflation coming down in the back half of the year, then the Fed would take that as an opportunity to slow down or maybe even pause. If they did pause, then history suggests that once they pause that is it. I can see a scenario where that plays out.

How does that impact government bond yields?

It suggests the two year is too high or maybe at a high this year. That’s an area in terms of duration, where I don’t think people should be afraid of.

Just thinking about the environment and commodities being at the peak of the cycle, there are a lot of energy companies that are sub investment grade and in the high yield space, do you have any concerns about them?

For the most part I would say the energy space is the most expensive right now. People in fixed income over-react to the spot commodity price in both directions. So, they thought it was crazy to buy energy company bonds when the oil price was zero and they think they’re crazy to not own lots of them when oil is at US$115. I don’t think either is correct in hindsight.

The good thing about credit is that they can only go so far, they are bonds. Were we to be wrong and oil goes to US$200, I think those bonds would go up two points because of the convexity profile. So, we’re happy to leave it alone, but not absolute zero.

Where do you see the opportunities now?

For the most part, we think Europe is the place to be right now. That’s because it’s been hit by geopolitics and rates combined.

The US is probably the most expensive as its seen as a safe haven and it’s got more energy sector exposure.

In the European space we like the banks based on how much systemic importance it has and therefore support is likely from government and regulators through periods of stress. National champion banks, particularly in Northern Europe are more recession proof than your average single ‘B’ high yield corporate. When their subordinated bonds, their Cocos – contingent convertibles trade wide to single B corporates, we think it’s a mis-pricing.

Do you see they are a little bit more resilient against higher inflation as well?

Possibly but they don’t behave well with interest rate volatility. So, its not so much about where the rate is, rather how much it’s jumping around. That’s really been the problem for that sector this year, but that’s also why I think it’ll be one of the first to bounce when that volatility subsides.

Can you also talk about the launch of Climate Change HY Fund which was launched last year?

The fund has a dual objective, it’s trying to be the benchmark but also decarbonise faster than the broader market and have a lower carbon footprint than the broader market. So, we appraise companies on their willingness and potential when it comes to decarbonisation. We look at how credible their decarbonisation policies are, and to what extent they can move the needle with what they do.

Interesting sectors in that respect include steel and cement, metals and mining. This is not a ‘go and find a tech company and a bank’ and call it a low carbon fund. This fund is about impact and engaging with those companies and working with them to hold them to account and shorter term milestones.

Its quite an innovative fund that has a dual mandate  and it has tripled in size since we launched in August last year.

Some of the investments will be sustainability linked bonds (SLBs) others will be straight bonds of companies we think are relevant to the mandate. SLBs are assessed using our internal framework and we consider if the penalties are draconian enough and whether the targets are ambitious enough. If both are satisfactory, then we’re more than happy to pay for the premium for the SLB bond as opposed to the company’s straight bonds.

If not, we treat it as a straight bond and if it’s not compelling enough, we look to something else.

Fraser Lundie – CFA, Head of Fixed Income – Public Markets, Federated Hermes Limited

Fraser joined in February 2010 and is Head of Fixed Income – Public Markets and lead manager on the range of credit strategies. Based in London, he is responsible for leading the strategic development of the Credit platform and investment teams, offering solutions accessing all areas of the global credit markets. Prior to this, he was at Fortis Investments, where he was responsible for European High Yield. Fraser graduated from the University of Aberdeen with an MA (Hons) in Economics; he earned an MSc in Investment Analysis from the University of Stirling and is a CFA charterholder. In 2017, Fraser joined the board of CFA UK, a member society of the CFA Institute, where he also sits on their Sustainability Steering Committee, as well as the Professionalism Steering Committee overseeing the society’s advocacy and thought leadership work. He has previously featured in the Financial News’ ‘40 Under 40 Rising Stars of Asset Management’, an editorial selection of the brightest up-and-coming men and women in the industry, and was also named as one of the top 10 star fund managers of tomorrow by the Daily Telegraph. Other notable accolades have come from Citywire Americas, which named Fraser number one in their global high yield manager review, and InvestmentEurope and Investment Week, which both named the Federated Hermes Multi-Strategy Credit Fund top global bond fund at their respective 2017 Fund Manager of the Year Awards.


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Elizabeth Moran
Editorial Director
Elizabeth is a nationally-recognised independent expert on fixed income. She has more than 25 years experience in banking and financial institutions in Australia and the UK and has been published in every major Australian newspaper and investment website. Prior to becoming an independent commentator in 2019 she spent more than 10 years as the head of education and research at fixed income broker FIIG Securities. Prior to joining FIIG, Elizabeth worked as an Editor/Analyst for Rapid Ratings a quantitative credit rating agency. She also spent five years in London, three working as a credit rating analyst for NatWest Markets.