Fast forward to 2023, however, and things look drastically different. After a terrible 2022 – the Bloomberg global aggregate index, a broad measure of global fixed income, fell over 16% during the year1 – so far, 2023 has been pretty good. A key reason for this is that much of the pain of 2022 came because of extreme moves by central banks intent on curbing inflation.
The US Federal Reserve raised interest rates seven times, taking the fed funds rate from 0.25% in January of 2022 to 4.5% in December, the highest level since 20072. The Bank of England went even further, hiking rates eight times over the same period.
This saw bond prices plummet and yields, which move in the opposite direction to prices, jump. As a case in point, at the start of 2022, there was $14 trillion worth of negative yielding bonds in the market. In January that number had shrunk to zero – the first time since 2010 that there has been no negative yielding debt3.
On top of this, many investors are currently far more sanguine about the market outlook than they were at the start of last year. As our 2023 Fund Selector Survey shows, while inflation (70%) and interest rates (63%) remain the chief portfolio concerns, three quarters of fund selectors also believe that rising interest rates will usher in a resurgence in bonds.
An inverted yield curve – when short term bonds offer higher yields than longer term bonds – is considered by many to be an indicator of recession and typically happens when investors believe that interest rates are likely to continue to go higher in the near term.
As Julian Dauchez, head of Portfolio Consulting at Natixis Solutions points out: “Looking at the portfolios we analyse, investors are favoring the short end of the yield curve in the US, in Europe and most developed markets. Now, things will evolve and come the end of the year, when we believe bond market volatility will recede as short-term rates find their terminal level, there is an expectation that the yield curve will steepen again and offer meaningful opportunities in the long end of the curve.”
As Julian Dauchez, head of Portfolio Consulting at Natixis Solutions explains: “This year, there is expectation that decorrelation between bonds and equities may gradually come back as inflation recedes, but investors are also taking a proactive approach by diversifying their portfolios with alternatives. Liquid, non-directional strategies as well as illiquid alternatives – and those such as infrastructure which can also offer inflation protection for institutional investors – are being favored by investors.”
Diverse minds fuel insightful ideas. And ideas mean opportunities.
- Bond – the ‘bond market’ broadly describes a marketplace where investors buy debt securities that are brought to the market, or ‘issued’, by either governmental entities or corporations. National governments typically ‘issue’ bonds to raise capital to pay down debts or fund infrastructural improvements. Companies ‘issue’ bonds to raise the capital needed to maintain operations, grow their product lines, or open new locations.
- Duration – A measure of a bond’s sensitivity to changes in interest rates. Monitoring it can effectively allow investors to manage interest rate risk in their portfolios.
- Fixed income – An asset class that pays out a set level of cash flows to investors, typically in the form of fixed interest or dividends, until the investment’s maturity date – the agreed-upon date on which the investment ends, often triggering the bond’s repayment or renewal. At maturity, investors are repaid the principal amount they had invested in addition to the interest they have received. Typical fixed income investments include government bonds, corporate bonds and, increasingly in recent years, green bonds. Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
- Yield – A measure of the income return earned on an investment. In the case of a share, the yield is the annual dividend payment expressed as a percentage of the market price of the share. For bonds, the yield is the annual interest as a percentage of the current market price.
- Yield curve – Essentially, it is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. So, the curve shows the relationship among bond yields across the maturity spectrum – this is considered ‘normal’ when the yield on long-term bonds is higher than the yield on short-term bonds. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year US Treasury debt. It is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates, and it is also used to predict changes in economic output and growth.
2 Source: https://www.federalreserve.gov/monetarypolicy/openmarket.htm
3 Source: https://www.ostrum.com/en/news-insights/news/mystratweekly-january-10th-2023
4 Source: https://www.ft.com/content/a6c270d8-78e0-4df8-bf61-24fd6f914924
This material is provided for informational purposes only and should not be construed as investment advice. Views expressed in this article as of the date indicated are subject to change and there can be no assurance that developments will transpire as may be forecasted in this article.