Fixed income has been the focus of much attention in recent months, with many investors concerned the bond bull market may be coming to an end. Market conditions have indeed changed – central banks are cutting back on quantitative easing (QE), inflation appears to be on the rise and interest rates look set to increase further.
However, the impact and extent of these changes are unclear. Taking a closer look at bond yields over time paints a more positive picture, and encourages investors to take a more strategic approach to the bond market.
Where have yields been historically?
Looking back at the evolution of the US 10-year bond yield over the past three decades, many investors will be surprised to see that it was close to 10 per cent in 1987 and has trended downwards all the way to the current level of less than 3 per cent. European and UK bond yields have followed a similar trajectory over the 30-year period, with a number of corrections on the way. Prior to the global financial crisis (GFC) – in the period between 2000 and 2007 – yields were around 5 per cent and were in fact considered low for the time. The current yields are therefore nothing new.
Focusing in on the past decade, yields have continued this downwards trend. The driver of this trend can be explained in two words: central banks. The US Federal Reserve was the first to react to the GFC by launching a QE programme in 2008, and the Bank of Japan and the European Central Bank launched their own versions of QE in 2014 and 2015 respectively. The impact of this was a sharp drop in global bond yields.
As the Fed was so much further along in the cycle than other global central banks, it was ready for the first interest rate hike since the GFC in December 2015. Despite the Fed having raised rates five times in a cycle, yields remained anchored. This is because of the effect of 'exported QE', which we will explore later.
Should investors be worried?
We have seen a swift rise in the 10-year US bond yield, which is now approaching 3 per cent. At the same time, there has also been an increase in volatility, with the CBOE Volatility Index reaching a multi-year high of 50. Consequently, many industry commentators are now talking of the start of a bear market in bonds.
Investors have been concerned that the bull market in bonds is coming to an end
Central banks are reducing their support of the markets with QE
Interest rates are rising but they are not expected to rise substantially
The environment is changing, but it is important to bear in mind that this is a process of normalisation – central banks are withdrawing the extraordinary emergency measures they employed to offset the effects of the GFC. They are now acting from what they feel is a position of strength, the emergency measures having succeeded in meeting their aims with global growth improving.
What should investors bear in mind?
Firstly, it is difficult to anticipate how the market will respond. Similar headlines about the US 10-year bond hitting a 3 per cent yield proliferated at the beginning of 2017. However, last year, global fixed income enjoyed its best year in a decade, with the Bloomberg Barclays Global Aggregate Bond Index returning 7.4 per cent in US dollar terms (2.04 per cent in sterling) to investors.