After the financial crisis first took hold, conditions proved highly supportive of bond markets.
Indeed, as volatility abounded in equity and property markets, cash continued to offer poor value – as the era of low interest rates took hold – and investors’ appetite for risk remained low, bonds have been a clear winner for shrewd investors.
However, economic indicators suggest this run may soon be coming to an end, with yields rising from their lows of last year and bond fund performance under increased pressure. The question now seems to be not whether there will be a correction in the bond market but, rather, when it will happen.
On the face of it, the influx of cheap liquidity into the markets as a result of quantitative easing and low interest rates has fuelled a build-up of debt and driven bond yields to levels that are not supported by domestic economic fundamentals. Added to that are the first signs of a rotation back into risk assets, alongside growing confidence of sustained – albeit slow – recovery in the global economy and a rise in interest rates in the medium term. However, while the market can anticipate a phase of deleveraging and bond yield rises, it is still unclear how sharp the bear market is going to be and whether it is likely to happen in 2013.
Following the strong rally in 2012, as concerns over the eurozone led more investors to opt for the perceived safety of UK gilts and bonds, some commentators, including Ewan McAlpine, senior client portfolio manager of fixed income at Royal London Asset Management, now anticipate increased stability.
“Since the beginning of the euro sovereign debt crisis, gilts have benefited from a safe-haven premium,” he says. “However, euro debt markets have become calmer following the announcement in August 2012 by the ECB of its Outright Monetary Transactions operations. At the same time, economic data from the US has been generally more positive. Consequently, the UK’s safe haven premium has been unwinding and gilt yields have risen; 10-year gilts have risen from their August 2012 low of 1.4 per cent to as high as 2.2 per cent in February 2013. Most forecasts for gilt yields this year are higher – and higher still for 2014 – but we have no reason to believe the rise will be sharp, however.”
Similarly, Salman Ahmed, fixed income strategist at Lombard Odier Investment Managers, suggests there will be a sell off later in the year following the arrival of a new Bank of England governor, who he thinks may implement changes to support higher inflation against a backdrop of low growth.
“UK bonds have been soggy recently because of this change and because of the growing realisation bond markets can no longer rely on the Bank of England using bond purchases as the main method of pumping money into the economy, as has been the case in the past,” he explains. “Compared with US treasuries and German bunds, UK gilts are more affected by inflation concerns, especially since rises in consumer prices remain well above the Bank of England’s target.”
