THE dramatic rise in bond yields in the second half of 2016 has once again roused those wondering whether the end of one of the longest and strongest bond ‘bull markets’ seen since the late 13th century is upon us.
The level of developed world bond yields certainly remains inappropriate, increasingly so, in the context of a world economy where the prospects for growth and inflation continue to firm. Surging business and consumer confidence in the US is coinciding with a brightening economic picture almost everywhere else in the world.
Headline inflation even seems to be rebounding from its oil price crush in Europe, while US wages are now on a less questionable upward trajectory. All this points to a world with good and improving growth prospects – something analysts are already factoring into their earnings expectations.
Of course, safe haven enthusiasts will note the herd of political elephants about to stampede into the room, from President-elect Trump’s impending inauguration to the various electoral minefields in Europe’s path this year. For the moment, we prefer to focus on that improving economic backdrop as the primary driver of investments. We expect the political backdrop to remain noisy, but not the dominant factor in our investment thinking for the most part.
A potential exception here concerns the president’s inclination to act unilaterally on trade. The significant but indirect benefits of trade can be hard to perceive directly – consumers may simply not realise the extent to which they sell to, and buy from, overseas.
On the flip side, its costs are concentrated and arguably far more observable – cheap imports have hit American manufacturers, particularly in the Midwestern 'Rust Belt' and the South. This, alongside the inexorable march of technology, has decimated American (and other developed world) manufacturing jobs in the last decade in particular.
For our part, we do not currently envisage developed world inflation running out of control, but can certainly imagine above-target inflation in the US and UK in coming quarters. US fiscal plans are certainly going to be important to watch carefully, as is the progression of US wages. However, arguments based on a reversal of globalisation and the resulting effects on interest rates likely fall too far into the speculative category to be of much practical investment use.
Investors will need to continue to tread carefully and lightly in the higher quality areas of the bond market, being sure to keep duration low. For our part, we remain tactically underweight high quality government and corporate debt and our recommended medium risk portfolio holds a very low strategic weight to the former in any case.
With the cycle having further to run and default rates likely remaining low, we still see merit in investors taking selected credit risk, a likely necessity for those looking for acceptable real returns from the fixed income complex in coming quarters.
:: Jonathan Dobbin (jonathan.dobbin@barclays.com) is head of wealth and investment management NI at Barclays. He can be contacted on (028) 90882925
