Fixed income markets have not fared as poorly as many had expected in 2017.
Analysts, strategists and even bond managers lined up at the end of last year to provide opinions on how far yields would rise. But six months on, anyone geared up for a bear market was positioned incorrectly. The yield rises witnessed in the second half of 2016 were supposed to mark the end of the bond bull market, though year to date yields across almost all fixed income markets have fallen.
At the end of June, the yield on a benchmark 10-year gilt was below its level prior to the global bond sell-off last November, and bar a recent wobble, the pattern has largely held the same for corporate bonds. So what has driven these moves?
Much is still pinned on central bank intervention. Near-term rises in government bond yields were prompted by hawkish comments from European Central Bank chairman Mario Draghi and Bank of England governor Mark Carney.
In spite of this, Treasury yields are down this year and capital gains stand at around 1.7 per cent, data from FE Analytics shows. A 10-year US Treasury started 2017 with a yield of 2.44 per cent and then fell to a low of 2.17, but was trading at 2.35 per cent last week.
Such low yields mean long-term valuations remain stretched, according to many analysts, meaning government and investment-grade debt still only really finds support as a diversifier.
However, bonds’ correlation with stocks remains well above long-term trends. UK government bonds and equities have a correlation of 0.66 year to date, compared with a 10-year average of -0.12.
Movement in the corporate bond space has not matched expectations, too. Spreads between corporate and government bonds were expected to rise in 2017 – reflecting a more positive environment for inflation and growth. But corporate bond indices are up, and yields are down – with the US market returning 3.7 per cent in 2017, and sterling bonds gaining 2.7 per cent. The BofA Merrill Lynch Euro Corporate index has risen 0.7 per cent in the period.
M&G Investments head of retail fixed interest Jim Leaviss says he has begun reducing corporate bond exposure due to valuation concerns, rather than increasing credit risk.
But investors remain perplexed over how to approach fixed income. Chris Iggo, fixed income chief investment officer at Axa Investment Managers, describes the 2017 market as “better-than-expected returns, lower-than-expected yields”.
He says that despite sustainable inflation coming back to core developed markets, figures are still below target in the US and Europe. In the UK, rising inflation – which is down to sterling weakness –may be temporary, while wobbles in the oil price have raised concerns over price increases stalling elsewhere.
Mr Iggo says this, combined with the disappointment of a lack government fiscal stimuli boosting growth, has meant lower yields and flatter yield curves. “We see little change in this environment in the near term, but higher yields and a steeper US curve on a slightly longer-term view,” he adds.