Where are the global yield hotspots?

But with central banks on different monetary policy paths, which regions are proving to be the yield hotspots?

Figures showing flows into fixed income can reveal a little more about which regional bond markets investors are favouring.

Nick Gartside, international chief investment officer, fixed income at JPMorgan Asset Management, observes inflows across bond sectors have been “overwhelming” year-to-date, even compared to last year which he recalls was a strong year for flows.

A supportive central bank can do wonders for your regional corporate bond market, especially when one of the measures they are embarking on is a monthly bond-buying programme.Ben Willis

“Investment grade (IG) credit has been a particular beneficiary, with the US market receiving $68bn of inflows so far this year, compared to $28bn for the same period last year and $63bn for all of 2016, and the European market seeing year-to-date inflows of $29bn versus just $15bn in 2016,” he says.

Mr Gartside adds: “The momentum of positive flows in emerging market debt (EMD) is also exceeding last year, with nearly two-thirds of last year’s flows already gathered. 

“Even US and European high yield, which have registered fund outflows year-to-date, are indirectly experiencing demand via flexible ‘go-anywhere’ bond funds, which are generally putting the $25.5bn of year-to-date inflows to work in risk sectors such as high yield.”

Figure 1: Sum of EMD, US IG and aggregate funds (US$m)

Source: JPMorgan Asset Management, Bloomberg

Flow data may paint a picture of where money has been going up until now, but working out which regions might be best for yield in the future may require a closer look at a country’s central bank stance.

Europe and UK

“A supportive central bank can do wonders for your regional corporate bond market, especially when one of the measures they are embarking on is a monthly bond buying programme,” points out Ben Willis, head of research at Whitechurch Securities. 

“Given this, Europe has been favoured for some time and this has led to price increase and yield compression. Therefore, on a relative basis, the US is looking more attractive generally, particularly as they are in a position to raise interest rates.”

According to AXA Investment Management’s Nicolas Trindade, a senior portfolio manager, the main opportunities to increase yields can be found in the UK and European high yield markets.

Source: AXA Investment Managers, Bloomberg

There also seems to be agreement European yields have reached the bottom.

Mr Trindade notes: “We expect yields in Europe to go higher, not lower. Pick-up in growth and inflation will cause the ECB to announce tapering of its QE programme  in the fourth quarter of this year, with any subsequent rate hike not taking place before 2019.”

Mr Willis adds: “With regards Japanese and European bond yields these can go lower but it is unlikely that either of the central banks will be cutting base rates from here. 

“It has been largely acknowledged that moving to negative interest rates was a mistake, so it is more likely that moves in interest rates will be upwards – this would mean an increase in yields, although don’t expect this in the near-term.”

Emerging market local currency bonds certainly have yield potential.Salman Ahmed

For investors who want to look beyond the developed markets for yield though, there are opportunities in emerging markets.

Salman Ahmed, chief investment strategist at Lombard Odier, suggests: “Emerging market local currency bonds certainly have yield potential. This comes with substantial currency risk, but we also feel that many currencies remain substantially undervalued following the ‘taper tantrum’ in 2013 and the subsequent improvement in fundamentals.”

Emerging market debt is a good source of yield, agrees Mr Willis, but he cautions investors need to be comfortable with the risk, “as these bonds can sell off fast and hard when volatility and risk aversion are prevalent”.

Withstanding volatility

Al Jalso, senior portfolio manager at Russell Investments, also recognises local currency emerging market debt provides an attractive yield.

He cautions: “Over an extended period we see potential for this sector to provide compelling returns but investors will have to withstand local EM debt’s inherently high volatility.”

He outlines a couple of scenarios in which emerging market debt would be subject to increased volatility: “A sharp increase in US closed-border policy, which could drive inflation and surprise Fed policy rate increases, could drive up the US dollar, injecting risk and volatility into this trade. 

“Likewise, a global growth slowdown would make EM currencies less attractive, also heightening volatility.”

In the US, it is widely agreed the Federal Reserve is on a rate-raising path, although there are obstacles.

We expect the Bank of Japan to stick with its ‘yield curve control’ framework in 2017 but the 0 per cent target might be adapted with a ‘tolerance range’.Nicolas Trindade

Mr Jalso explains: “The Fed is confounded by a lack of inflationary pressures and a flattening curve – witness the spread between the two and 10-year US treasuries, denoting the curve’s steepness, recently breaking down through the 1 per cent barrier. 

“The Fed will be reticent to drive the curve much flatter without fundamental inflationary pressures, so probably won’t hike aggressively.”

He adds: “US rates are also constrained to the upside by their relative attractiveness versus European, UK and Japanese rates. We don’t expect this dynamic to change any time soon as the ECB will keep monetary policy loose for the intermediate term and Japan for the long term.”

The Bank of Japan appears to be sticking to its central bank stance for now. What does that mean for yields?

Mr Trindade notes: “We expect the Bank of Japan to stick with its ‘yield curve control’ framework in 2017 but the 0 per cent target might be adapted with a ‘tolerance range’, as rising treasury yields could make it more difficult to sustain this target i.e. we could see Japanese yields go slightly higher.”

In the search for yield, therefore, investors should be able to pinpoint some hotspots but they will need to be vigilant of monetary policy and the type of environment in which central banks may have to change course.

eleanor.duncan@ft.com