Three triggers of a 2014-style bond market correction

Three triggers of a 2014-style bond market correction

There are three scenarios which could lead to a market correction similar to the one which took place in 2014, according to M&G's Carlo Putti.

The investment specialist on the fixed income team said the environment now felt similar to that of 2014, when markets were becoming very relaxed about the global economy, asset prices were rich and volatility was low, but then there was suddenly a sharp sell-off.

The cause of that correction was the falling oil price and fears about an economic slowdown in China.

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Mr Putti has identified three factors which could lead to a similar correction now: central banks unwinding their balance sheets, tensions over North Korea and a policy mistake.

He said: “With 583 rate cuts globally and $50trn (£38trn) of central bank liquidity injections since 2008, it appears we are finally at a turning point. The consensus in the market is that global economic growth will pick up and inflation will eventually move towards target. This is not very different from where we were three years ago."

Mr Putti warned that markets can experience a significant re-pricing event without sliding into recession.

He warned that investors "simply do not know" what will happen when the central bank "big buyers" leave town, because nothing on this scale has ever been done before.

Mr Putti also said geopolitical risks are always a threat, but North Korea in particular stands out.

He said: “Tensions between the US and China have been rising recently, particularly because it doesn’t seem like China is really putting pressure on North Korea as the US was hoping.

"In the short term, it will be interesting to see how Trump reacts if this situation doesn’t change.”

He added Trump may once again accuse China of currency manipulation if it doesn’t support him on North Korea.

Meanwhile a monetary policy mistake could also lead to a market sell-off, Mr Putti suggested.

He said: “Recently, we have seen a slowdown in macroeconomic data, particularly in the US where core inflation has been trending lower for the last four months. It is now at 1.4 per cent, the lowest level since 2015.

"If this situation persists, the Fed may end up hiking rates in a low inflation environment, putting pressure on the economy as real interest rates rise.”

Mark Benbow, fixed income fund manager at Kames Capital, also pointed to the interest rate risk. He believes bond investors are unwittingly being exposed to higher duration.

Debt issuers are increasingly seeking to lock-in low borrowing costs for longer periods, raising the interest rate sensitivity of bond benchmarks, he said.

Bond yields have declined to record lows in recent years, thanks in part to the extremely accommodative monetary policy implemented globally by central banks.

In response, corporates and governments are issuing long-dated bonds in an effort to lock-in all-time low borrowing costs for extended periods.