Bond investors have a bit of a dilemma: the market is behaving quite logically.
That is according to Iain Stealey, chief investment officer for global fixed income at JPMorgan Asset Management. His view is that government bond yields have risen for rational reasons; markets fear above-target inflation for longer and the level of government bond issuance has been high.
Meanwhile, in the corporate bond market, including high yield, spreads have been tight, something which should be happening if corporate earnings are strong enough to justify the levels of growth in equity markets, as it implies companies are generating the cash to pay the coupons on the bonds.
Nick Hayes, head of total return and fixed income allocation at BNP Paribas Asset Management, says the relative underperformance of government bonds in such a climate is perfectly logical, as those tend to be risk-off assets that perform best when investors expect a growth shock.
The current climate is one in which investors are more concerned about inflation than growth, and in which corporate earnings look solid, creating the very opposite of the conditions in which government bonds are designed to thrive.
He adds that the nature of the inflationary pressure, coming from a supply shock in the economy, rather than an uptick in demand “makes investors very nervous” about government bonds.
Gabriele Foà, a portfolio manager in the global credit team at Algebris Investments, says a major change in fixed income markets in recent years has been the end of government bond buying by central banks, which has pushed the prices of those assets down, while liquidity remains abundant in the economy as a whole.
His view is that central bank buyers have been replaced by buyers that are “price sensitive”, and those investors are wary of the level of issuance of new government bonds, and so have not been willing to buy all of the newly issued bonds at the prevailing interest rate, thereby pushing the price down, and the yield up.
A particular manifestation of this right now is that government bond buyers are reluctant to own instruments with a long date to maturity, instead focusing on shorter dated bonds, as those have less sensitivity to rising inflation.
But he says the relative strength of the economy and of investment markets more generally means there is both the liquidity and the risk appetite to own corporate bonds, as well as equities.
James Klempster, deputy head of multi-asset at Liontrust, is a little keener on government bonds, commenting that the yields have now reached a level where they are attractive in their own right.
