The year has started badly for fixed income, but ultimately, it may bring greater opportunity as yields rise.
- Gilt funds are down an average of 6.4% since the start of the year
- Investors fear central banks will be forced into a panicked rate rising cycle when inflation takes hold
- Ultimately it may restore some normality to fixed income markets and create opportunity.
It’s been a tough start to the year in fixed income markets, with many investors sitting on uncomfortable losses in apparently ‘safe haven’ asset classes. Gilt funds are down an average of 6.4% since the start of the year, global bonds are down 3.2%, while sterling corporate bonds are down 2.7%. It appears that the long-awaited fixed income reckoning has arrived.
The immediate catalyst for these problems is higher inflation expectations. A combination of a chunky stimulus package in the US, on top of an economic recovery and central banks committed to long-term loose monetary policy has got investors worried about rising prices. The fear is that central banks will be forced into a panicked rate rising cycle when inflation takes hold.
These fears have good foundations. The latest Composite PMI data in the US showed a reading of 58.8. Anything over 50 suggests economic expansion and the current reading is the highest for 71 months. With the vaccine rollout proceeding at pace and economic activity returning to normal across the US, rising prices look like a real possibility.
At the same time, markets appear to find the attitude of the Federal Reserve disquieting. Fed Chair Jay Powell said: “The economic recovery remains uneven and far from complete ... The economy is a long way from our employment and inflation goals and it is likely to take some time for substantial further progress to be achieved”. It seems unlikely that the Federal Reserve is unaware of the inflation risks, but many people believe it may be careering towards a policy error.
For investors, rising bond yields require a change of mindset. The so-called ‘long duration’ trade, which favoured the long-term cash flows from fast-growth technology stocks is waning, replaced by a more cyclical trade. It means volatile times in fixed income over the next few months as markets readjust.
That said, ultimately it may restore some normality to fixed income markets and create opportunity. For some time, it has been difficult to find yield in fixed income, which has been a problem for investors as other income sources such as commercial property have also been weak. This brings yield back to fixed income, which would be welcome.
It may not be the time to buy just yet, but it is certainly a better time to be invested in fixed income than just a few months ago. It is re-opening choice to multi-asset investors.