By Colin Harte, investment manager of the Baring Global ond Trust It has been suggested by some that...
By Colin Harte, investment manager of the Baring Global ond Trust
It has been suggested by some that the events of the past couple of weeks mark the end of the long bull market in bonds. Others believe we have been presented with a great buying opportunity. We, however, remain sceptical.
Over the long term, there is some risk inflation will be higher than investors are expecting and clearly this would be negative for bond markets. However, in the short to medium term, we believe the economic data is likely to remain mixed, triggering swings in sentiment as concerns over inflation or deflation dominate.
Active duration management will be the key to achieving satisfactory investment returns in this volatile environment.
It became increasingly difficult to justify the low levels of government bond yields in recent months, at a time when equity markets were showing strong returns in anticipation of better economic and corporate profits growth. In early June, we moved to increase our short duration position in investment portfolios.
The immediate trigger for the sell-off in bond markets was the Federal Reserve's decision on 25 June to cut short-term interest rates in the US by 0.25% instead of the 0.5% anticipated by investors. This decision was accompanied by a statement that appeared to show diminishing concern for deflationary risks while being fairly upbeat about the economy.
The effect of this, when combined with the prospect of an increase in new bond issuance as public finances deteriorate and renewed interest in equities, was a sharp fall across global bond markets.
Yields on benchmark US and German 10-year bonds have risen by almost 0.5% from their lows last month, while yields on UK Gilts are back where they were two months ago.
We believe the reaction of the markets has been extreme and have therefore reduced the extent of our short duration position in the face of this setback in the bond markets.
The risk for the US economy is that the decline in the bond market will have a real economic effect. Falling bond yields have encouraged companies and homeowners alike to refinance their debts more cheaply. These supports for growth, and indeed for the equity market, will be undermined if bond yields continue to rise.
Over the longer term, we believe the major risk to bond markets is probably that the trend rate of economic growth in the US is overestimated and that monetary policy will remain too stimulative for too long as a consequence. In this environment, inflation-protected bonds are likely to come into their own.
In the short-and-medium term, however, we expect bond markets to move quite sharply on economic data and newsflow concerning the pace of growth as fears about inflation and deflation come and go.
We believe this will be an environment in which active management of bond portfolios, and management of the duration in particular, will be key to achieving satisfactory investment returns.
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