Although risk is growing, UBS Investment Management believes the U.S. economy will struggle on without actually slipping into negative growth. UBS is still favouring credit sensitive sectors for the incremental income they offer compared with the Treasury agency sector.

According to UBS’s September fixed income update, the attractiveness of bonds is having an abrasive effect on Treasury yields, plunging in the intermediate and long end of the yield curve in August as fears of a double-dip recession grow.

“On-going weakness in the housing market, flagging consumer confidence, and the prospect of higher taxes have clouded the investment outlook, while regulatory uncertainty is worrisome to business leaders,” the report states. “While we acknowledge that the odds of a double-dip recession have increased, we view the disappointing economic data as a ‘soft patch’ and believe that growth will remain positive.”

While placing faith in fixed income markets when there are record-low yields presents a challenge, UBS expects performance to be muted over the rest of the year and is advising a neutral tactical allocation to fixed income.

In the area of corporate bonds, UBS is advising investors retain an overweight allocation to investment grade and high yield credit and favor BBB-rated corporates, with 4- to 7-year maturities.

When it comes to preferred securities, they favor lower duration trust preferreds (TruPS) that are more likely to be called at par, rather than higher-duration discounted securities and advise taking profits in premium baby bonds.

UBS recommends investors reduce exposure to short-dated maturities and stick to high-quality sectors in municipal bonds. The fixed income team favors essential purpose revenue bonds in the water/sewer and public utility sector, special tax and general obligation bonds.

(09/02/10)

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