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.
Rates set to stay higher for longer
During a busy period for rate decisions, the Bank of England and US Federal Reserve both hit pause, while the European Central Bank made a small increase to interest rates.
While this may signal the top for interest rates, it does not mean that they will fall soon, according to analysts.
AXA Investment Management’s chief investment officer Chris Iggo says that both rate pauses were “hawkish” in nature, meaning that the messaging was that they intend to keep interest rates elevated and the battle against inflation isn’t won yet.
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“It’s obvious that investors need to factor in a higher interest-rate regime than the one that has prevailed for most of the last 20 years,” Iggo said.
Nevertheless, he notes that “higher for longer” is not a normal situation.
Iggo points out: “Since the 1970s, there has only been one example of the Federal Reserve keeping rates at the peak of the cycle for an extended period. That was in 2006-07 after the policy rate had been raised from 1% in 2003 to 5.25% in early 2006. Rates stayed at 5.25% for 15 months.”
He says that policy tightening is normally quickly reversed because normally there is more of a reaction from the economy.
He goes on: “I wonder if we might be in more of a 1995-2000 situation. The Federal Reserve raised rates from 3% in 1994 to a 6% peak in 1995. A few adjustments followed until a new peak was reached at 6.5% in 2000, just enough to burst the dotcom equity boom.”
What does this mean for bonds?
Bond investors like to invest at the peak of interest rate assumptions so that they can capture the highest yields, as well as the most capital gains if rates are cut again.
For much of this year they have been wrong about interest rates, as yields have kept rising (due to falling bond prices). The 10-year maturity US government bond index is down nearly 5% this year and the equivalent UK gilt index is down 6.5%.
- Everything you need to know about investing in gilts
- Bank of England holds rates at 5.25% after inflation surprise
But investors at home should not be overly concerned about capturing the bottom of the bond market. Instead, the yields on offer should be one of the main reasons they are drawn to the sector, particularly as currently short-term bonds yield more than long-term bonds.
For example, two-year UK gilts yield 4.7% and one-year gilts yield 5.1%. Gilts are free from capital gains tax, making them particularly attractive to investors.
Corporate bonds yield more due to the extra risks involved, with the typical sterling investment grade corporate bond now paying about 6.5% if held to maturity.
M&G fixed-rate bond launch
Fund groups are working to offer investors a fixed yield by launching funds that have a fixed maturity date, similar to an individual bond, but with the added benefit of more diversification.
M&G Investments is the latest group to do so, offering European Union and Switzerland-based investors the option to lock in yields between 4.6% and 4.8%, in euros, over an 18-month period.
- Day in the life of a bond fund manager: M&G’s Eva Sun-Wai
- Benstead on Bonds: why UK investors are getting a great deal on bonds
It is doing this by investing 65% of the portfolio in investment grade debt. Fees are 0.8% a year in the most expensive share class.
While UK investors will not be allowed to invest, it shows how fund managers are attempting to offer investors a fixed return from the bond market, via a fund format, which is something that many income seekers will value.
Of course, they can already do this by investing in short gilts, but picking the right bond can be a trickier process than trusting a fund group with the process.
Read our guide on investing in gilts for how you can lock in a fixed return of around 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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