Fixed Income Outlook: Rates likely to outperform credit
We started 2020 with a cautious view on valuations in global credit markets, and we continue to de-risk portfolios. China, in particular, is likely to remain in risk-off mode for some time, with rates outperforming credits. The credit risk/reward ratio is now even less compelling than it was, due to slower China growth and the impact of the virus on global supply chains.
Our portfolio managers are therefore increasing long exposure to US and Australian sovereign bonds, reducing short positions in European and UK sovereign bonds and reducing credit exposure to those sectors most interconnected with Chinese manufacturing, e.g. autos, commodities and chemicals.
Additionally, we take a cautious view that residual effects of the outbreak, even once it is under control, could weigh on fixed income risk assets. So rather than buying market dips, we are monitoring the situation and taking chips off the table where valuations remain rich.
Next month presents critical test
The next month will be a critical test in terms of assessing the economic damage wrought by the virus, with potentially important implications for our global outlook. While contagion rates appear to be slowing, the physical measures taken to combat its spread are more stringent than SARS and may bite harder into economic activity. As the costs of government support mount up, they may set back Chinese attempts to de-leverage.
For now, the assumption among many of our companies is that the impact of the virus will be relatively short-lived and (like SARS) disappear as the summer arrives, triggering a snap-back in economic data, aided by Chinese government assistance to markets and the real economy.
 Source: CEIC, Fidelity estimates: https://www.ceicdata.com/en/china/resident-departure/resident-departures
 Calculation is based on the assumption that China Q1 growth falls by 1-2pp yoy (or around 6pp in qoq annualised terms on average). Its PPP weight in the global economy is about 20 per cent so the direct impact on global growth would be 1.5*0.2=0.3pp or 30bp. The indirect impact via trade and tourism is around 0.2pp (in line with literature). This gives you around 0.5pp in total (or around 2pp in qoq annualised terms).
 Source: Wood Mackenzie, 2020