Where is the future value in bonds?

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Where is the future value in bonds?
Bonds have been an acutely volatile investment over the past year. (Ann H/Pexels)
ByDavid Thorpe

Bond investors are not paying attention to policy makers, which is why they have been pouring cash into fixed-income assets. 

According to Ian Brady, chief investment officer at WH Ireland, the reason for this is that while central bankers have not really altered their rhetoric regarding their determination to lift interest rates until inflation falls back toward the 2 per cent target, many investors expect a shift in policy, with rates cut at some point this year.

But is this definitely the direction in which central banks are going?

Brady believes UK inflation could "stick at around 3.5 to 4 per cent this year, which, as it is above the target, won’t be enough of a fall to mean central banks alter course."

Dickie Hodges, who runs the £2.1bn Global Dynamic Bond fund at Nomura, agrees with Brady’s analysis, telling FTAdviser “the market got ahead of itself” at the start of this year in anticipating a move from central banks towards a looser monetary policy, and rate cuts. 

I still expect bond yields to be lower at the end of this year than they are now.Dickie Hodges, Nomura

Brady and Hodges also agree that an economic downturn is likely to occur later this year, and that this will likely lead to interest rates being cut at some point, but they believe the market has underestimated the timing and extent of the cuts.

However, while both professional investors have a similar view of the trajectory of the market from here, they are presently taking radically different views on how best to allocate to fixed income.

Great expectations

Typically, if an investor thinks a recession is coming, they allocate to long duration bonds. This is because, bonds issued today, have yields which reflect interest rate and inflation expectations at the present time.    

An economic downturn would usually be expected to be deflationary, and policy makers would usually cut interest rates to stimulate economic growth.

In that environment, bonds with yields that reflect a higher interest rate and inflation world may look attractive to investors who are otherwise presented with lower yields. 

And the longer a downturn persists, the longer is the period before interest rates rise and the value of the bonds previously issued at higher interest rates. 

Brady accepts the logic of the above, but instead is buying bonds with a short date to maturity.