Rates & Reflation: Tackling the big questions in Fixed Income
The first quarter of 2021 has certainly been an interesting one for fixed income investors, with government bond yields rising significantly, particularly in the US. With many excitedly talking about reflation, Chris Iggo, Chief Investment Officer at AXA IM, and Nick Hayes, Portfolio Manager, shared their thoughts on recent developments across bond markets and thoughts for the future.
You can find a short summary of their views below.
What’s the view on government bonds, particularly in the US?
A combination of a rapid vaccine rollout and falling COVID cases has boosted investor optimism on US growth, with some expecting US growth to register at 7.5% or more this year. As a result, ten-year US Treasury yields have risen by around 80 basis points over the first quarter.
The size and speed of this move has led some investors to question whether the Federal Reserve will act to support markets. As of the end of March, markets are pricing in a rate rise in 2022 and then further rises in 2023, in contrast to what the Fed is saying it will do.
We think ten-year yields will likely rise to 2% in the near future, and that this could present an attractive opportunity to buy Treasuries. No-one has the ability to predict exactly where yields will top out, so we might see the market overshoot that level, but as we head towards 2%, we think that we will start moderating our bearishness and potentially start to add.
What will happen to inflation?
Headline inflation will pick up over the next few months, simply because of the time periods being compared (i.e. a recovering economy today vs. an economy which was experiencing the initial shock of a pandemic and associated lockdowns). At the extreme end, for example, oil prices are relatively normal today, whereas one price benchmark turned negative around this time last year. In these circumstances, it would be almost impossible to not see a rise in inflation.
The key question is whether this pick-up is temporary or longer lasting. We believe it will be temporary and see little evidence as yet of sustained inflationary pressures, such as with higher wages.
Is higher risk fixed income still attractive?
We are still constructive on fixed income risk, providing you can be flexible and selective with your investments. It is very easy to dismiss a market because its headline yield is too low, but there will always be individual credits within a market which yield significantly more.
While there are still opportunities within the US high yield market, they are becoming scarcer. We could be interested in longer duration credits if the pressure on duration continues, but we are not quite there yet.
Our view on emerging market debt is fairly neutral, having been outright bullish a few months ago. We have a preference for hard currency over local currency, with the latter seeing the majority of the sell-off in recent weeks. More specifically, we like the bonds of sovereigns benefitting from support programmes such as that of the International Monetary Fund, as well as high quality EM corporate bonds whose issuers have robust balance sheets.
 Morgan Stanley, March 2021.
 Bloomberg, March 2021.