Fixed Income  

Fund Review: Global bond markets facing a year of potential land mines

Fund Review: Global bond markets facing a year of potential land mines

Global bond markets in 2016 had a positive year overall, with net retail inflows into the sector for nine of the 12 months to the end of November 2016.

However, further into this year, the potential for new fiscal policies from president Donald Trump, the start of Brexit negotiations, a weaker pound and rising inflation could present problems for government bond investors. For credit, though, the picture is less alarming. 

Grégoire Sharma, associate at Signia Wealth, says: “The second half of 2016 saw the return of the ‘reflation’ theme and a pickup in global growth momentum as confirmed by the December global PMIs. US 10-year treasury yields rose by 80 basis points following the US elections results and are expected to breach the 3 per cent level this year.

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“Bond spreads have narrowed and default rates remain low supporting the credit space, although valuations are not cheap by historical standards. Generally, credit spreads are still trading at materially higher levels relative to their 2014 lows. In the emerging markets space, economic fundamentals have improved coupled with the recent commodity price tailwind and a better outlook for China. However, risks remain with the Trump administration’s protectionist stance and the potential effects of a stronger US dollar.”

Inflation and the US presidency are the key headwinds for the start of the year, with the first quarter house view from Aviva Investors noting that, while inflation has picked up steadily over the past year, “the higher pace has not caused any great panic. Were that to change, the correction could swiftly become more alarming, raising the risk of a repeat of 2013’s ‘taper tantrum’ in terms of sovereign bond yields”. 

The report adds: “Any perception of sustained inflation overshoots and a growing perception that central banks are behind the curve would lead to a sharp sell-off in real rates and a spike in break-even inflation rates. Significantly higher bond yields and a reassessment of the pace of central bank tightening would probably hit risk assets in general, boost the dollar and undermine emerging markets.”

Meanwhile Chris Iggo, chief investment officer, fixed income at Axa Investment Managers, suggests European fixed income markets have been fairly quiet as “European markets have been dragged higher by the focus on the US while longer term core bond yields are in positive territory”.

But he continues: “For all the focus on politics, the fundamentals do still suggest that the rate outlook will dominate what happens in bond markets this year. The data continues to move in a positive direction. 

“There are lots of ways to generate performance in bond portfolios: being in the right bond asset class, having the right level of duration and credit risk, and exploiting market dynamics like carry, quality and relative value. A very important one is macro-momentum and a belief that interest rate assets and credit assets react in different ways to the macro outlook is a basic of top-down investing in bond markets. Until there is a change in the macroeconomic environment and the data starts to weaken, high yield should continue to outperform Treasuries. The thing to watch, of course, is how far this can go and what it means for relative valuations.”