The endless bond bull market
Oct 14, 2014
By Bob Michele
A lot of downside risk in fixed income has been removed and investors should take advantage of strong investment opportunities that have formed in the bond market
Patient bond investors have been rewarded in 2014. A zero interest rate policy around the world and low volatility are forcing cash into bond markets, continuing to hold down government bond yields and bolster risk assets.
It would seem this is proof of the old dictum ‘Don’t fight the Fed.’ For investors, that applies as well to the European Central Bank, the Bank of England and the Bank of Japan, all of whom have pursued coordinated unconventional intervention to pump liquidity into global markets.
There are few signs to suggest that this dynamic is going to dramatically shift anytime soon. In our view, the sub-trend economic recovery will continue in 2015, with global GDP growth averaging between 2 and 4% and global inflation remaining benign between 0 and 2%. Central banks will continue to provide the necessary liquidity until they see broader economic strength and/or material wage inflation, although the balance of that transition for the US Fed will be closely watched.
We expect the Federal Reserve will move to raise the fed funds rate in mid-2015 and that may be a test for the bond markets as the opportunity for profit taking arises. That said, the Fed is well aware of the potential risk of the first rate increase in eight years and will proceed carefully with normalization.
Given the amount of liquidity central banks have pumped into the system and the resulting stability it has created, a lot of the downside risk has been removed — investors should take advantage of these strong investment opportunities that have formed within the bond market.
KEEP IN PERSPECTIVE
Investors have to keep record low government bond yields in relative perspective, especially in the case of U.S. Treasuries which currently offer marginally better returns than many other sovereign bonds. There is only so long investors can sit in cash earning a 0% return in the U.S. — perhaps a negative yield in Europe — before bonds prove to be a more desirable weighting.
We continue to like high yield bonds, where credit spreads look attractive. The sector should continue to benefit from low default rates and the investor search for yield. We continue to like corporate credit where companies are acting as prudent borrowers and doing a good job managing their balance sheets.
In terms of the investment implications, today’s environment underscores a trend we’ve been seeing for some time that is quickly gaining momentum: a shift from traditional, benchmark-oriented fixed income strategies to more benchmark-agnostic, flexible approaches.
The ability to shift irrespective of a benchmark allows managers to be nimble in adjusting sector and duration exposure in response to changing market conditions. These next generation unconstrained bond strategies are free to seek out the most attractive risk-adjusted return opportunities whilst maintaining the characteristics of a bond portfolio. Rising flows in recent years to this category would suggest investors believe they are likely better suited for today’s uncertain bond investing landscape. This may be particularly relevant around the market’s next big test as it looks ahead to the first Fed funds rate increase.
Bob Michele is CIO and head of global fixed income, currency & commodities at J.P. Morgan Asset Management