Sam Benstead breaks down the latest news affecting bond investors.
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.
US inflation drops to 3%
Price rises in the United States are falling back to a healthy level, prompting investors to buy shares and bonds on the expectations that interest rates may not have to rise much more in the world’s largest economy.
The CPI inflation figure for June came in at just 3%, below forecasts. Geir Lode, head of global equities at fund manager Federated Hermes, said it suggests there is “light at the end of the tunnel” in America’s fight against inflation.
Lode said: “The Federal Reserve is looking for a softening labour market and low inflation before it begins to cut interest rates. And so, while today’s figures are a positive step forward, there is still more work to be done. The latest jobs report plays a similar tune with a lower-than-expected US jobs report – good news for the Fed’s price stability goal – but unemployment remains at a historical low.”
He reckons that while the central bank has signalled two more rate hikes this year, the stock market rally suggests that it could be fewer. US interest rates are currently in a range of 5.0% to 5.25%.
“The softer figures plays into the market’s view, but it is difficult to see the central bank changing tactic in the short term, so we expect a 0.25% increase in July,” said Lode.
- Investors dump UK funds and buy bonds
- Bond Watch: tax rules and 5% yields drive investors to gilts
- Investing in bonds: should you buy funds, trusts, ETFs – or invest directly?
- Fixed income trades surge 879%
US government bond yields fell in response to the news, as investors bought bonds and drove up prices.
However, there’s the risk that if and when a US recession materialises, the Federal Reserve will be too slow to cut interest rates, warns Arif Husain, chief investment officer for fixed income at T. Rowe Price.
Husain cautions: “The Federal Reserve indicated it will take into account the cumulative effects of policy tightening when determining how much more to raise rates, signalling it is likely to take more time between hikes. But will this prove adequate to forestall a recession?
“The stickiness of core US inflation and the Fed’s focus on returning inflation to its 2% target could easily lead the Federal Reserve to move rates too high and be slow to cut when the economy enters recession.”
What are the best ways to invest in bonds?
Tempted by high bond yields, but not sure where to start? This week we published an explainer on bond funds, trusts, exchange-traded funds and direct bonds. It delved into the advantages and disadvantages of each way of investing, and looked at different investment ideas.
One of the key takeaways is that open-ended funds are best suited to liquid investments, such as government or investment grade bonds, while investment trusts are better suited to illiquid investments, such as asset-backed bonds (like bonds linked to mortgages) or private lending.
- Bond Watch: why UK interest rates could hit 6.5%
- Day in the life of a bond fund manager: M&G’s Eva Sun-Wai
- Why bonds are back and how you can invest in them
Another important point is that the value of a bond fund will change when bond prices rise or fall, often linked to interest rates.
This means that the total return from owning a bond fund may be negative, even though yields are high at the moment.
To counter this, investors can own direct bonds and hold them to maturity.
The Order Book for Retail Bonds, from the London Stock Exchange, allows retail investors access to fixed income, such as bonds issued by companies or the UK government.
The most-popular direct bonds being bought at the moment by interactive investor customers are gilts.
They are buying up gilts set to mature in the next couple of years, with bonds maturing in 2024, 2025 and 2023 the three most-popular choices. This suggests investors are holding the gilts to maturity, locking in yields of more than 5%.
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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