Bond Markets

24 Jan 2020

Compared with investor expectations at the end of 2018, the path of interest rates and bond yields throughout the past year has proved surprising.  At that stage most economists were foreshadowing a number of positive adjustments by the US Federal Reserve (Fed) to its monetary policy, but in the event it felt able to implement three reductions during the course of the year, of which one fell during the final quarter now under review.

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Though President Trump may claim some influence in this pivot, having previously remonstrated with the Fed Governor Jerome Powell that US monetary policy was unnecessarily restrictive, the need for the Fed to offset the impact of trade tensions on both domestic and international confidence levels was paramount and the lack of any meaningful increase in US inflation provided the appropriate room for manoeuvre.  This lower path for US rates cushioned the impact of global trade tensions and was echoed by many other authorities around the world, though the pace of such action proved materially slower during the fourth quarter, in part because some Central Banks (such as those in Europe and Japan) had little scope to loosen policy but also as hopes rose of a successful resolution to trade uncertainties.
While Central Banks are not forecast to tighten their approach in the near term, bond investors reversed their approach during the autumn which led to 10yr bond yields rising quite markedly in the fourth quarter.
Though policy remains extremely accommodative throughout the developed world, and Central Banks are not forecast to tighten their approach in the near term, bond investors reversed their approach during the autumn which led to 10yr bond yields rising quite markedly in the fourth quarter.  Gilt yields rose by 33 basis points to reach 0.82%, whilst US Treasuries recorded an almost identical increase to 1.92% and those across much of Europe reflected similar patterns, with most, except Germany and Switzerland, ending in positive territory: for example French 10yr yields moved from -0.23% at end-September to 0.11% at end-December. 
 
In Germany however, where economic growth has proved most disappointing within the Eurozone, yields ended the year at -0.19%, its least negative reading since May.  Sterling corporate bonds performed less poorly than gilts, thanks both to its index having shorter duration (so offsetting some of the impact on capital values from higher yields) and due to a slightly brighter climate expected by the year end.
 
As the chart below illustrates, the main Central Banks in the US, Europe and the UK have implemented very loose monetary policy throughout the decade that followed the financial crisis, with interest rates being kept below the level of prevailing inflation, except by the US for a brief period a year ago.  Until the global growth outlook appears more certain, we do not see much change in this stance, though there is scope, absent any threat of a US recession, for 10yr yields to edge a little higher.

Real policy rates

real policy rates

Source: JPMorgan Nov 2019

In contrast to the developed world, bond yields elsewhere offer returns mostly well above the prevailing rate of domestic inflation; countries such as Brazil and Mexico have 10yr yields about 3.5% higher than their local inflation rate, whilst the gap in South Africa is almost 5%, though of course those potentially attractive sounding numbers do come with associated local currency risks.

Capital returns to a sterling investor

Capital returns to a sterling investor

Source:Datastream

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