Fixed Income 

Investors may need to curb expectations

This article is part of
Fixed Income - January 2015

The outlook for fixed income markets this year will be determined by several macroeconomic events, such as monetary policy tightening and further quantitative easing programmes in Europe and Japan.

For many investors, this means that fixed income will be under pressure in 2015 and that they will have to lower their expectations in terms of returns from these types of assets.

Ben Bennett, credit strategist at Legal & General Investment Management (LGIM), suggests that investors’ expectations for 2014 fixed income markets were proved wrong early on in the year.

He notes: “It will take a little while for people to work out what that means for 2015. What I’m still hearing from quite a few sell-side investment banks that this year is when we’re going to see the increase in growth, interest rates will start to go up and it will be what we thought 2014 would be but delayed by a year.”

He questions the view that the worst-case scenario for fixed income will be a rise in interest rates by UK and US central banks.

“When discussing fixed income and headwinds, most people still believe the worst thing for fixed income is for interest rates to rise; that’s because it’s been ingrained in their minds for the past couple of years that we will, at some point, get higher interest rates because we’re going to get normalised policy,” he says.

“That, for me, is the benign base case. Yes, the total returns are not going to be great but they’re going to be okay. My downside for fixed income is the realisation that we’re in a deeper, long-term hole, which would be even worse for things like equity markets.

“The only reason why fixed income is bad under that scenario is because you have higher credit spreads,” he adds.

“If you just buy government bonds, that’s great as you lock in those lower interest rates. But if you buy anything in corporate bonds you get wider spreads, and that undermines your total return.”

Nevertheless, an announcement by US Federal Reserve chairwoman Janet Yellen signalling a return to normal monetary policy will have some impact on fixed income, so investors should be aware of the outlook should this happen later in the year.

David Kelly, chief global strategist at JPMorgan Asset Management, in a note on how to invest in fixed income this year, advises that once the Federal Reserve begins hiking interest rates – possibly around June – it will continue to do so at subsequent meetings in order to reach its long-term target of 3.75 per cent by 2017.

He says: “Such a scenario implies negative total returns along the entire Treasury yield curve for maturities of two years and above during 2015. Consequently, this should be a year to be underweight Treasuries and short duration in the US.

“Treasury inflation-protected securities are also likely to provide negative returns in 2015 since the increase in nominal Treasury yields is likely to come from higher real yields rather than higher inflation.”