REPEAT:Portfolios:Loomis Sayles:US 10Y To Rise 35-40b Thru '18

Repeats Story Initially Transmitted at 14:42 GMT Nov 20/09:42 EST Nov 20

--Favors 5Y-7Y Pat of US Yield Curve;2/10Y Flattening To Slow in 2018

--Defensive on G3 Rates; Likes Shorter Hard Currency EM Corporates

By Yali N'Diaye

     OTTAWA (MNI) - With U.S. growth to accelerate in 2018 and the Federal

Reserve continuing its tightening, albeit at a still moderate pace in light of

tame inflation, the U.S. 10-year benchmark government bond yield is likely to

increase a further 35 to 40 basis points through the end of 2018, said Lynda

Schweitzer, a co-portfolio manager Loomis Sayles Global Bond Fund.

     Such an increase would be "modest," she told MNI, and is supported by the

fact that other major central banks will be on hold: while the Fed will raise

once in December 2017, a widely shared view, and twice next year, the European

Central Bank, which could end its QE program after the recent extension while

continuing reinvestments, is unlikely to hike rates before the second half of

2019.

     Meanwhile, the Bank of England "will mostly be on the sidelines through

2018" given that inflation will have peaked in the fourth quarter of 2017 and

that uncertainty around Brexit will remain.

     As for the Bank of Japan, it "will most likely leave all easing policies on

hold throughout 2018."

     Still, upward pressure on yields over the coming year will continue amid

strengthening global and U.S. growth, leaving the portfolio manager defensive on

G3 - U.S., European, Japanese - rates. The U.S. 10-year yield was trading around

2.36% Monday morning, the German equivalent at 0.36%, the UK at 1.30% and the

Japanese at 0.03%.

     That caution is expressed through a preference for shorter duration bonds,

favoring the 5- to 7-year part of the curve, expecting the 2- to 10-year to

flatten, but at a "slower pace" than the 50 basis points experienced so far this

year.

     When looking at shorter-term bonds "with a bit of extra yield," the

portfolio manager finds opportunities in the securitized market.

     "In agency mortgage-backed securities (MBS), we are slightly underweight

but have been active in the ABS and CMBS segments of the securitized market,"

she told MNI.

     She also likes "to take our local rates exposure in select emerging markets

countries with improving fundamentals."

     Within the emerging market universe, fund flows have been slowing down,

reaching $14 billion since late September, according to the latest Institute of

International Finance Latest portfolio allocation trends. However, much of it

owes to country-specific events such as the growing risk of a NAFTA collapse

that sent exposure to Mexican assets to their lowest level in more than six

years.

     The IFF said its Fund Position Indices suggest that investors have adopted

neutral positions in emerging market bonds for the first time in 35 weeks.

     The cautious approach is leading investors to favor hard currency

securities to minimize foreign exchange risk, with a preference for corporates

over sovereigns, and high yield over investment grade.

     At Loomis Sayles, "we also think shorter emerging markets hard currency

corporates offer good value for our portfolios," said Schweitzer.

     Within developed markets, the Global Bond Fund is defensive on G3 rates due

to expected upward pressure on yields over the next 12 months.

     Instead, the portfolio managers favor corporate bonds, with a preference

for investment grade over high yield across the three markets.

     "Corporate fundamentals are expected to remain solid given our economic

backdrop so even though spreads have tightened over the last 18 months, we still

like the extra yield versus Treasuries," Schweitzer told MNI.

     She favors banking and insurance paper, and select energy names, although

recent analysis from credit ratings is suggesting caution.

     While S&P Global said in a report Thursday that "the outlook for global

credit markets is favorable as credit conditions remain satisfactory," it noted

that globally, oil and gas, and financial institutions were among the sectors

most likely to see downgrades.

     In the U.S., according to Moody's, IG credit spread could exceed 106 basis

points at the end of 2017, while high yield spread could rise to 410 basis

points by the end of this year.

     In terms of default, however, the U.S. high yield trailing 12-month default

rate is expected to decline to 2.2% by the third quarter of 2018, from 3.2% in

October this year.

     And in Europe, Fitch Ratings said the risk of a turning point in high yield

has increased.

     "The relative absence of volatility - and its distortion due to

quantitative easing - obscures the true risk-return dynamics faced by investors,

increasing uncertainty about HY market dynamics," Fitch said.

     Still, the portfolio manager sees opportunities in both U.S. investment

grade and high yield corporate bonds.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com