Fixed Income  

Bond investors have ‘every reason to worry’

This article is part of
2016 Review - A year to remember for investors

Bond investors have ‘every reason to worry’

In a year of unforeseen events the first ports of call are so-called ‘safe haven’ assets, including fixed income and, in particular, government bonds.

But with Brexit and the US election result occurring in a year where bond yields have fallen to new lows, how have fixed income investors fared in 2016? The answer is they have had to endure something of a rollercoaster ride. 

Frank Engels, head of fixed income at Union Investment, highlights: “2016 has been a challenging year for international capital markets so far. Worries about the sustainability of China’s growth model, uncertainty surrounding global monetary policy, the Brexit vote and the election of Donald Trump – markets had to deal with numerous event risks and temporary spikes in volatility. 

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“Up until the Brexit vote, gilt, bund and Treasury yields had marked record lows this summer. German bunds even traded in negative yield territory from mid-June until the beginning of October. With declining yields, the prices of many bonds increased to levels that could be perceived as increasingly out of touch with fundamentals. That was the case not only for developed countries but also emerging markets, which strongly outperformed almost all other fixed income assets on the back of a pick-up in commodity prices since mid-February.”

Nick Wall, portfolio manager of the Old Mutual Global Strategic Bond fund, points out: “Despite many analysts forecasting higher yields in 2016, bond markets spent most of the year rallying. The final [straw] came after the UK’s vote to leave the EU led to a wave of central bank dovishness: the Bank of England cut rates and restarted quantitative easing (QE); the Fed held off from hiking interest rates and lowered its terminal funds rate; and the Bank of Japan announced it would cap 10-year Japanese government bond yields at 0 per cent. The returns on fixed income were spectacular and, ultimately, unsustainable.”

But while the start of 2016 had seen bond yields plummet, stronger-than-expected data from both the UK and globally has changed the picture in the second half of the year. 

Azim Meghji, head of UK fixed income at Santander Asset Management, notes bond markets reacted positively as a combination of low inflation, growth and the UK referendum vote resulted in looser monetary policy, but adds a shift has now begun.  

“This has all changed in the past couple of months with the US election supercharging yields. A fiscal boost in the US is expected to increase US growth, inflation and yields. Although medium-term impediments to higher growth, inflation and yields remain – demographics, high levels of debt, low productivity – the path of least resistance in the short term is for higher yields.”

Jim Leaviss, head of retail fixed interest at M&G, adds: “With the Republican Party in control of both the Senate and Congress, president-elect Trump should have the political power to advance his headline economic policies of infrastructure spending and cuts in corporation tax. As a result, investors are expecting a significant increase in government borrowing, and government bond yield curves tend to steepen against such a backdrop.