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.
Rates hit 4.25% in the UK
The Bank of England raised interest rates 0.25 percentage points to 4.25% this week, marking its 11th consecutive rate hike.
By raising the cost of capital, it is seeking to slow down the economy and control inflation, which is still above 10% in the UK.
Central banks around the world are grappling with high inflation, but are also being forced to take into account weakness in the financial system.
Credit Suisse (NYSE:CS) was acquired by UBS (SIX:UBSG) after the Swiss central bank was forced to step in to provide liquidity, while Silicon Valley Bank (NASDAQ:SIVB) in California collapsed after huge losses on its bond portfolio.
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Analysts expected a 0.25 percentage point rate rise from the Bank of England, but now see the bank pausing its rate rises.
Gurpreet Gill, global fixed income strategist at Goldman Sachs Asset Management, said: “Strong domestically generated inflation in February led the Bank of England to deliver a 0.25 point rate hike, but we continue to see a case for a pause after today given the expected drag on growth from past policy tightening and recent financial market volatility.”
The US also increases rates
The Federal Reserve in America also increased interest rates by 0.25 percentage points this week, in a move that signalled it was not worried about risks to the banking system following the crisis, which started with Silicon Valley Bank.
Its decision was expected by investors, whereas a cut or pause in increasing rates would have been interpreted as a sign that the central bank was worried and knew something that outsiders did not about the health of the economy.
Bond markets hardly moved in response to the interest rate decision, while stocks fell modestly on comments from chair Jerome Powell that there is a risk to economic growth due to higher borrowing costs.
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Neil Birrell, chief investment officer at Premier Miton Investors, commented: “The Federal Reserve is juggling beating inflation, avoiding recession and making sure the financial system remains secure. That is quite a challenge and, unsurprisingly, they have moderated their stance on inflation and gone for a 25bps hike.
“This was accompanied by comments which indicated that further tightening may be necessary, although that language is softer than last time.”
Time to buy corporate bonds?
In the event of a recession, now that interest rates are near their peak, bonds could once again become a defensive asset, rising in price as investor worry increases, but also paying out a stable income.
This is the view of Legal & General Investment Management (LGIM), which sees pockets of opportunity in fixed income markets and is not worried about banking issues spreading more widely.
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The fund manager likes the safest category of corporate bonds, known as investment grade, arguing that credit spread (the extra yield from owning corporate rather than safe government bonds) is attractive and investors are therefore being rewarded for taking a position in the debt of financially secure companies.
LGIM expects declines in bond yields, caused by rising bond prices, throughout 2023. It therefore prefers longer-dated bonds, which should rise the most in value as yields fall.
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