Rocketing US bond yields over the past few months has been met with nods of satisfaction from commen...
Rocketing US bond yields over the past few months has been met with nods of satisfaction from commentators who have been recently been parading the 'bond bubble' banner.
But there are other explanations for poor bond performance, namely that it is a normal response to an improving macroeconomic situation.
As an Invesco Perpetual analysis says: "Since mid-March, US 10-year bond yields have risen by around 20 basis points and the equity market has risen by 9%: that conjunction of developments is exactly what one would expect in an environment of improving economic growth."
However, not everyone believes this is the full story. Bill Gross, managing director at Pimco, for example, thinks there are new pressures from global competitors that will limit the recovery. This ominous judgement informs his view that this makes the current environment significantly different from other times when this economic situation has appeared.
Gross says that, in the past, whether yield rises happened because of the natural movements of the market or because actions of the Federal Reserve, recovery continued as higher interest costs were absorbed by companies regaining their pricing power. However, it might be different this time around.
"Today the recovery is structurally different," he warns. "Global competitors - including China, India, Brazil and a host of others - limit pricing power by ferocious trade policies, whether they be currency-based or cheap labour-orientated."
US companies have started to employ more people, but those people happen not to live in the US.
"A new and stultifyingly different business structure means profit margins - after the benefit of redundancies and higher productivity are dissipated - will be negatively affected by interest rate increases. If so, the recovery will ultimately flounder."
Despite the debate continuing on future economic recovery, the current situation is that the government bond markets are relatively settled and the lack of volatility has had a generally positive impact on investor confidence.
Isis notes the September press statement from the Federal Open Market Committee was almost the same as the one from August.
The only changes were a worse view on the labour market, and reinforcing the idea that the main inflationary dangers lay on the downside, despite general economic improvements.
According to Isis: "The Fed is clearly anxious not to deviate from its message that interest rates will remain unchanged for a considerable period."
The effect of the slump on bond fund managers has been predictably painful. In the Standard & Poor's Sector Update, the ratings agency noted the effect of the slump in June and July was particularly bad at the long end of the maturity range, with 10-year yields taking a brutal 130 basis point beating.
It is not surprising that many fixed interest managers have therefore seen substantial outflows from their funds in this period.
The report continues: "Against this rapidly changing investment environment, the most successful management strategy proved to be an emphasis on short duration and the short end of the yield curve.
"One of the most aware managers to the new scenario was Investec, where a dramatic reduction in duration from almost nine to three years, coupled with a move to the short end of the yield curve, saw the group's Guernsey-domiciled USD bond fund rebound to second quartile performance in the sector over the three months to the end of July, from bottom quartile in the previous quarter."
Standard & Poor's found funds investing in mortgage-backed securities were particularly badly hit by the yield hikes, which led to a severe slowdown in prepayments, hurting performance.
Evidently managers of these funds have put great emphasis on the long-term nature of their products.
The expectation is that the funds will recoup much of the recent underperformance once the yield volatility comes down to kinder levels.
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