Interactive Investor

Bond Watch: fixed income’s ‘once-in-a-generation opportunity’

2nd December 2022 09:38

by Sam Benstead from interactive investor

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Sam Benstead breaks down the latest news affecting bond investors.

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Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

‘Once-in-a-generation opportunity’ in emerging market debt

Abrdn says that while US interest rate hikes, a strong US dollar and a struggling Chinese economy paint a bad outlook for emerging markets, there are many reasons to be cheerful.

One is the high yields, with abrdn saying that arguably the single most important valuation measure is the yield level.

The firm points out: “The history of emerging market bonds shows that it’s always preferable to buy at historically elevated yields. This makes sense because with higher yields the starting level of recurring income (from coupon payments) is high and there’s greater potential for price appreciation whenever yields revert lower over time.

“More defensively, in the event of prices staying weak, a sizeable income component can have a cushioning impact for total returns.”

At the end of October the yield on dollar-denominated emerging market government bonds was about 10%, around double the rate just a year ago, and well above the 20-year average of 6.43%. For comparison, during the period of heightened pandemic uncertainty, the index yield peaked at 7.99% on 19 March 2020, abrdn notes.

Another reason to be bullish on emerging market bonds is that in most countries inflation now appears close to peaking, according to abrdn. Central banks there should be able to first pause tightening and then eventually begin easing policy to support growth, the fund manager argues.

US rate hikes set to slow

US Central Bank boss Jerome Powell signalled that the pace of interest rate rises in America would begin to slow as soon as this month.

“The time for moderating the pace of rate increases may come as soon as the December meeting," he said in a speech this week.

In response to a question, he said that he was wary of overtightening – raising interest rates too rapidly so that the economy is badly impacted in the fight to control inflation.

His remarks suggest a 0.5 percentage point hike in the middle of the month, breaking the pattern of 0.75 point rises in each of the past four meetings.

Powell’s speech sparked a rally in stock and bond markets, with the S&P 500 finishing Wednesday up 3%, and yields on US government bonds – which move inversely to price – falling from about 3.8% on the 10-year to 3.6%.

BlackRock backs investment grade bonds

BlackRock’s Investment Institute said this week that investment grade corporate bonds are its favoured way to tap into the newly improved yields available from fixed income markets.

It said the case for investment-grade credit “has brightened” and it now suggests investors go “overweight” that part of the bond market.

“We think it can hold up in a recession, with companies having fortified their balance sheets by refinancing debt at lower yields,” it wrote in its 2023 markets outlook.

However, the funds giant said that government bonds would struggle next year, with most stocks and bonds moving in the same direction because central banks would be reluctant to cut interest rates amid stubbornly high inflation.

It said: “Central banks are unlikely to come to the rescue with rapid rate cuts in recessions they engineered to bring down inflation to policy targets. If anything, policy rates may stay higher for longer than the market is expecting.

“Investors also will increasingly ask for more compensation to hold long-term government bonds – or term premium – amid high debt levels, rising supply and higher inflation.”

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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