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SEP Fixed Income Viewpoints 2021

onset of COVID-19, likely hit peak growth in the first quarter TheViewpoints series gives investors Lazard’s perspectives this year and has reported softer economic data since April. The on the latest macroeconomic and fixed income news United States appears to be following now, with weaker retail sales and trends. It reflects the views of the firm’s dedicated lately and a stunningly weak labor report for August: The specialists, who independently manage portfolios across the economy added only 235,000 jobs compared with expectations entire range of and sectors. for more than 700,000. Europe, where growth seemed to be in the latter stages of the Divergences of Opinion V-shaped recovery, is a possible exception to the prevalence of Hopes were high that September would at last bring clarity for sharply diverging views. Two of Europe’s big uncertainties— fixed income investors. With another batch of mixed economic elections in Germany and potential change in European Central data over the past month in the United States and Asia, however, (ECB) policy—looked likely to resolve in market-friendly the uncertainties that have prevailed in recent months—from the ways, according to Lazard’s experts. direction of growth, inflation, and rates to the timing of the ’s taper of purchases—have not yet been United States: Debating “Transitory” resolved. Instead, uncertainty seems to have given rise to strong Inflation “divergences of opinion,” as bond traders and politicians alike In the United States, divergence of opinion was perhaps most attempt to see meaning in hazy economic data. apparent on an issue that is top of mind for bond investors: At their monthly meeting in mid-September, Lazard’s fixed inflation. The Fed, the Biden Administration, and many investors income professionals delved into these differing opinions. At the still view higher US inflation as transitory, stemming mainly heart of the matter is the question of how the global recovery will from supply bottlenecks as the global economy reopens. Others, evolve as each region reaches the end of the V-shaped rebound including some members of Congress, see inflation as a longer- that began last year. China, the first to bounce back after the lasting effect of massive US fiscal stimulus in response to the

HB30294 2 pandemic. Indeed, the US Consumer Price Index (CPI) rose 0.9% For investors, Evergrande’s woes raise important issues: Will the and 0.5% in June and July, respectively, and held at an annualized selling that drove Evergrande’s bonds to 27 cents on the dollar rate of 5.4%, far above the Fed’s 2% inflation target. It rose 0.3% spread to other high emerging markets securities, and will the and dropped to 5.3% for August, offering hope to the “transitory” government allow such a big entity to fail? camp but failing to truly clarify the issue. Evergrande’s troubles began last year when regulators introduced Other recent inflation indicators from around the world have “three red lines” setting limits on leverage, specifically -to- been troubling. Freight costs have soared almost 27% from a year equity, cash-to-short-term debt, and liabilities-to-assets ratios. ago to hit the highest level since 2006. And as the US Producer Despite cash infusions from state-linked companies and asset Price Index (PPI) reached 8.3% for August, China’s PPI came in sales over the past year, Evergrande has failed to meet the new at 9.5%, 50 basis points (bps) above expectations, and even Japan requirements, investors have lost confidence, and in late August, reported a relatively high 5.5%. “How this plays out will be very the company warned that it may if it cannot sell more important,” noted an analyst at this month’s meeting. “Either CPI assets. As the biggest high yield bond in Asia, Evergrande’s and PPI will converge, or companies will come under a lot of profit slide has helped drive the yield on the Bloomberg China Dollar pressure as they absorb higher costs.” High Yield Index to 13%—as high as it was during the global pandemic. The Push and Pull in US Treasuries However, the problems at Evergrande and some other, smaller Despite relatively high inflation, US Treasury bond yields developers with heavy debt burdens are well contained, in the remained quite low, with the 10-year in a range around 1.30% view of our experts. While spreads have widened in China’s over the past month. Our US experts noted the divergence of market, they have not reached distressed levels overall, and new opinion there as well. On one hand, the rising market, lower issuance in the real estate sector has continued. A further slowdown downside risk from COVID-19, and indications that supply in China’s real estate sector over the next 12–24 months is likely, bottlenecks have been largely responsible for recent mixed data though, as many developers are currently focused on reducing would all put the 10-year Treasury at least even with forward- leverage rather than starting new projects; that, in turn, will likely looking inflation at 2%, one US expert noted. On the other lower demand for some commodities, including steel and copper, hand, demand from overseas buyers looking for yield and from according to Lazard’s specialists. US funds rebalancing portfolios is keeping longer-term Treasury bonds strong and yields low. “That dynamic is likely to It was still unclear whether the government would intervene in break, and I believe it will break to higher rates,” our US specialist Evergrande’s case. Just last month, China opted to recapitalize the said. country’s biggest manager, Huarong Asset Management. Although Evergrande may present less systemic risk, as do The credit markets, which entail higher risk and can be a good not typically lend directly to developers, many people’s savings and indicator of how well a is functioning, remained wealth are tied up in real estate. “There was too much moral hazard very strong as well. This has been a boon to US companies, which in China, and now the government has been slowly allowing can borrow at very low rates in a strong economy. “It’s a good onshore defaults and managing through them outside of the thing because companies will be able to do what we need them to courts,” an emerging markets specialist explained. “It isn’t smooth, do: create jobs,” noted an analyst. Buyers have snapped up credit but we believe it’s a healthy adjustment.” securities mainly because, despite historically low spreads, they still offer higher yields than Treasuries do. In other emerging markets, many central banks continued to raise their policy rates in response to rising inflation, but as in many In fact, demand for bonds has been strong enough that Lazard’s other regions, inflation is widely viewed as transitory in emerging experts do not expect a big market disruption when the Fed markets. Our experts noted that the region is beginning to ascend decides to begin tapering its bond purchases. The taper had been the “V,” with companies gaining pricing power and economies widely expected to begin later this year or early next, but August’s showing signs of strength. weak jobs report could alter the plan, our bond experts agreed. “I think they’ll wait for a more normal labor market,” as one put it. Europe: Taper versus Recalibration Credit Wobbles in China As the ECB revised its outlook for growth in the euro area this year to 5% from 4.6% at its September meeting, Denmark reached Credit markets were not running as smoothly in China. The a remarkable COVID-19 vaccination rate of more than 80% country’s largest real estate developer, China Evergrande, appeared and was celebrating its full, official reopening—becoming one to be on the brink of default and was hiring advisors to look into of the first countries in the region to lift all restrictions. Nothing restructuring its $89 billion debt load just as our fixed income seemed to darken the sunny mood in Europe’s markets over the teams met this month. past month—not even an announcement from the ECB that it 3 would “moderately lower” its bond purchases in the Pandemic Credit markets, much like in the United States, have enjoyed Emergency Purchase Programme (PEPP). strong demand as a source of yield above government rates. Although most spreads remain tight, our European bond experts However, the region was not immune to divergences of opinion: still see opportunities in the financial sector, specifically in Was the ECB’s latest move an actual taper? The Additional Tier 1 (AT1) securities, a type of bank subordinated signaled the change not by specifying amounts but rather by debt. As European economies continue to rebound, our specialists changing its language concerning the pace of bond buying in its see the potential for spread compression—a rare opportunity in post-meeting statement. the credit markets of late. Bank overall are quite strong, Lazard’s European fixed income specialists agreed with ECB they added, with very low-cost funding available from the ECB, President Christine Lagarde that the change was more of a strong asset quality, large capital cushions, and very high liquidity. recalibration than a taper. A “moderately lower” pace could mean Although banks in southern Europe have lagged in the recovery, cutting its purchases from its second quarter average of €78 billion our experts believe the fiscal stimulus from the Next Generation per month to perhaps €65–€70 billion—but the ECB already EU fund will spur lending, helping to boost GDP as well. made that reduction a few weeks ago due to a summer slowdown On the political front, big change is in store for Germany: After in the markets, a European bond analyst noted. “So the official 16 years, Chancellor Angela Merkel is stepping down, marking reduction in purchases won’t really be felt,” he suggested. In only the third time since World War II that Germany has changed addition, bond supply should be light until year end because so leadership after such a long term. What’s more, her successor is far many governments funded themselves earlier this year. from certain. Polls indicate that none of the six candidates is likely The ECB made no changes to its other quantitative easing to win a majority of votes, making a coalition government almost programs, suggesting that policy will remain accommodative for certain. Although each party has its unique positions, Lazard’s now. The fate of the PEPP will likely be decided in December, teams felt that all of the more likely coalitions were supporters of with the program due to expire in March. “The closer we get to the euro area. the ECB’s December meeting, the more intense the discussion will be and the more noise we’ll have in the markets,” our expert A Long Transition predicted. While fiscal stimulus helped lift the global economy back to An inflation discussion will almost certainly be on the ECB’s agenda pre-pandemic GDP levels, progress from here, as stimulus wanes as well. Though viewed by many as transitory in Europe, too, and growth slows, will be more difficult. Economic data from year-over-year inflation has recently crept up to 2%–3%. The ECB the United States, in particular, is still inconclusive on growth currently forecasts inflation will peak this year and drop to 1.5% in and inflation rates, leaving Treasury yields in a holding pattern. 2023, but at December’s meeting, the bank will reveal its outlook Divergences of opinion are becoming more pronounced as this for inflation in 2024 for the first time, which may shed light on period of extraordinary uncertainty lingers, but investors’ appetite whether policy will need to remain accommodative to lift inflation for risk has remained strong, an encouraging sign to Lazard’s fixed toward the ECB’s 2% target, our Europe team pointed out. income professionals. Lazard Fixed Income Viewpoints

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This content represents the views of the author(s), and its conclusions may vary from those held elsewhere within Lazard Asset Management. Lazard is committed to giving our investment professionals the autonomy to develop their own investment views, which are informed by a robust exchange of ideas throughout the firm.

Important Information Published on 20 September 2021. This document reflects the views of Lazard Asset Management LLC or its affiliates (“Lazard”) based upon information believed to be reliable as of the publication date. There is no guarantee that any forecast or opinion will be realized. This document is provided by Lazard Asset Management LLC or its affiliates (“Lazard”) for informational purposes only. Nothing herein constitutes investment advice or a recommendation relating to any , commodity, , service, or investment product. in securities, derivatives, and commodities involve risk, will fluctuate in price, and may result in losses. Certain assets held in Lazard’s investment portfolios, in particular portfolios, can involve high degrees of risk and volatility when compared to other assets. Similarly, certain assets held in Lazard’s investment portfolios may trade in less liquid or efficient markets, which can affect investment performance. Past performance does not guarantee future results. The views expressed herein are subject to change and may differ from the views of other Lazard investment professionals. This document is intended only for persons residing in jurisdictions where its distribution or availability is consistent with local laws and Lazard’s local regulatory authorizations. Please visit www. lazardassetmanagement.com/globaldisclosure for the specific Lazard entities that have issued this document and the scope of their authorized activities.Information and opinions presented have been obtained or derived from sources believed by Lazard to be reliable. Lazard makes no representation as to their accuracy or completeness. All opinions expressed herein are as of the published date and are subject to change. An investment in bonds carries risk. If interest rates rise, bond prices usually decline. The longer a bond’s maturity, the greater the impact a change in interest rates can have on its price. If you do not hold a bond until maturity, you may experience a gain or loss when you sell. Bonds also carry the risk of default, which is the risk that the issuer is unable to make further income and principal payments. Other risks, including inflation risk, call risk, and pre-payment risk, also apply. High yield securities (also referred to as “junk bonds”) inherently have a higher degree of market risk, default risk, and credit risk. Securities in certain non-domestic countries may be less liquid, more volatile, and less subject to governmental supervision than in one’s home market. The values of these securities may be affected by changes in currency rates, application of a country’s specific tax laws, changes in government administration, and economic and monetary policy. Emerging markets securities carry special risks, such as less developed or less efficient trading markets, a lack of company information, and differing auditing and legal standards. The securities markets of emerging markets countries can be extremely volatile; performance can also be influenced by political, social, and economic factors affecting companies in these countries. Derivatives transactions, including those entered into for hedging purposes, may reduce returns or increase volatility, perhaps substantially. Forward currency contracts, and other derivatives investments are subject to the risk of default by the counterparty, can be illiquid and are subject to many of the risks of, and can be highly sensitive to changes in the value of, the related currency or other reference asset. As such, a small investment could have a potentially large impact on performance. Use of derivatives transactions, even if entered into for hedging purposes, may cause losses greater than if an account had not engaged in such transactions.