Why boring isn’t bad in bond markets
Harry Richards examines how bond markets have reacted to increased interest rate expectations and explains why ‘boring’ isn’t bad in bond markets.
![Harry Richards Jupiter Fund Manager, Fixed Income](https://www.jupiteram.com/uploads/2021/01/bb8e646cd10641a4d315a85e430ad492/harry_richards_350x350.jpg?v=1706874644)
The first few weeks of 2022 have been eventful for fixed income investors. Yields on US 10-year government bonds have shot from 1.5% to 1.8% and look like they have room to rise even further. So, what is going on? Over the last year, we have transitioned from accommodative central banks and governments, who were providing a large amount of monetary and fiscal stimulus to help support the economy in the wake of the pandemic, to an environment where that support is set to be withdrawn. This is being done in the form of interest rate rises and the tapering off of central bank asset purchase programmes.
The world is experiencing a spike in the inflation data and the powerful cocktail of supportive economic policies and supply chain disruption is largely responsible, in my view. Of course, fixed income markets are forward-looking, and are currently pricing in about five interest rate rises from the Federal Reserve this year in an effort to control inflation. The belief that interest rates will be swiftly increased, combined with the expected withdrawal and subsequent reversal of quantitative easing are causing some concern. In short, the market’s ‘safety net’ is being removed and investors are starting to get nervous about the ramifications. For example, the S&P 500 Index is currently nearly 6% down year to date, while the more tech-focused Nasdaq has fallen 10% in the same timeframe.
Fundamentally, we believe that nothing has drastically changed from the pre-Covid era. The world is still heavily indebted, many economies face challenging demographic issues caused by aging populations, and the rate of technological increase means that the cost of producing goods continues to decrease. These factors will continue to act as a headwind to global economic growth and should also put material downward pressure on inflation over time. As a result, we expect bond yields to remain at relatively low levels by historical standards.
Given the current uncertainty surrounding markets and the volatility we have seen so far this year, we believe it’s not a bad time to be a little bit ‘boring’ when it comes to investments in the bond market, in order to manage risk in a year which we believe will see bouts of material volatility. For example, we currently favour high yield bonds in defensive sectors with a relatively short time until maturity with government bonds in developed markets such as the US and Australia.
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