Fixed Income June 2017  

How sustainable are current yields in global economies?

This article is part of
How to build a robust yield into a portfolio

How sustainable are current yields in global economies?

The good times do not always roll, and while in 2011 bond fund managers were in a mini heyday, with plenty of liquidity, today is a different story.

Globally, there is a lack of liquidity, spreads are unattractive and even the higher-risk bonds which are offering better-looking yields may be carrying too much risk for too little cushion. 

Even equity dividend income, the next port of call for investors who couldn’t find an embarrassment of inflation-busting yield in fixed income, is looking less appealing.

But the biggest question mark of all hangs over the interventionist policies of central banks and what effect, if any, their monetary policy will have on bond yields.

Nicholas Wall, manager of the Old Mutual Global Strategic Bond Fund, states: “We do not believe current yields are sustainable at these levels, with demand for government bonds falling and the net supply, after taking into account quantitative easing, set to rise considerably.

“On the supply side, most governments continue to run deficits and increase their bond issuance. This has largely been offset by central bank bond purchases but we are past the peak of quantitative easing, where central banks were price-insensitive buyers.

“We are now moving towards an environment where private sector investors will demand a higher real yield to fund government deficits.”

Considerations

The point about central bank involvement and its effect on the sustainability of yield is an important one for investors to consider.

Jonathan Baltora, portfolio manager for Axa Investment Managers, believes to perform an analysis to see how sustainable current yields are in major economies, one has to “distinguish between those economies that are still under the influence of quantitative easing and those where unconventional monetary policies are not being deployed any more”.

Mr Baltora believes that in the first group, which includes the euro area, it is “likely that normalisation of monetary policy poses an upside risk to interest rates”.

He explains: “This is typically the reason why the European Central Bank, which already started to slow down the pace of asset purchases at the end of 2016, is being reluctant to simply use the word ‘taper’ or ‘tapering’, by fear of igniting a bond sell off.

“The word ‘taper’ in [former Federal Reserve chairman] Ben Bernanke’s terms back in 2013 signalled the end of the increase of the Federal Reserve balance sheet and is now associated with ‘taper tantrum’ – one of the biggest bond crashes of the past few years.”

That’s what is happening with those economies which are still under the influence of QE. But what about those where such intervention is no longer being employed?

Mr Baltora adds: “In the second group, technical factors such as the monthly bond purchase from the central bank, are less relevant and economic conditions are likely to play a greater role.”