Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.
BOND MARKETS have mostly been on the back foot since the spring, weighed down by interest rate uncertainty and stubbornly high core inflation. Headline rates of inflation have fallen, but that’s partly been down to movements in food and energy – volatile, non-core components.
Underlying today’s concerns have been signals from central banks that quite a bit of the heavy lifting still has to be done. While headline inflation numbers have been falling quite nicely, wage pressures continue to mount. That spells more money chasing goods and services in the months to come.
We saw those same signals resurface after policy setting meetings in the US and the UK in September. While central banks in both countries opted to skip another increase in interest rates, the accompanying statements were broadly hawkish, leaving the way open for further, small increases in rates if needed.
Inflation makes bonds worth less because it reduces the value of future capital and income payments. However, inflation mostly affects the prices of longer dated bonds. They have the most to lose from the cumulative effects of inflation over time.
The only time that’s not necessarily true is when markets believe interest rates are so high they are likely to result in a recession.
Government bond yields – which move inversely to price – reflect current concerns. In August, the yield on 10-year Treasuries broke above the 3.25% to 4% trading range that had been in place for the previous two years. Today, these bonds yield around 4.5%1.
Meanwhile, high short term interest rates – determined by the Bank of England’s Bank Rate in the UK or the Fed Funds Rate in the US – primarily affect short dated bonds.
Having said that, high rates tend to have an adverse effect on bonds of all maturities. That’s because interest bearing cash accounts are in direct competition with them. Bond yields generally need to be higher than cash yields to compete.
Bond markets hadn’t been anticipating the “higher for longer” interest rate scenario that moved centre stage this summer. Up until then, the consensus had been firmly behind cuts starting by early 2024. While rate cuts next year are still likely at some point, they’re no longer considered a one-way bet.
The Fitch downgrade of US debt at the beginning of August was driven by fears large Federal budget deficits will fuel the supply of debt. That’s a further reason for the US Federal Reserve to keep rates high.
Even so, the yields currently on offer look attractive to income seeking investors able to take a medium term view. 10-year gilts currently yield about 4.3% – only a little less than US Treasuries. Government bonds in other advanced countries including Australia, Canada, New Zealand and South Korea also currently trade on yields around the 4% mark or above.
When the tide in sentiment finally turns and markets begin to price in interest rate cuts, there should be scope for some capital growth too. The last time US 10-year bond yields were as high as they are currently was in 2007 and we all know what came straight after. Nominal yields plunged and prices rose through 2008 into January 2009 as the global financial crisis hit. This pattern then continued for a further four years after that3.
The Colchester Global Bond Fund currently features among Fidelity’s Select 50 list of favourite funds. Run by an experienced and stable team of managers, it is almost entirely focused on government bonds and has low correlations with both equities and corporate bonds.
This fund has the potential to work as a decent hedge against a sharper than expected economic downturn and as a high-quality, equity portfolio diversifier. At the end of last month, the Fund yielded about 3.7%, an amount that is not guaranteed4.
Source:
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. The Colchester Global Bond Fund invests in overseas markets and so the value of investments could be affected by changes in currency exchange rates. The fund uses financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund invests in emerging markets which can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Tax treatment depends on individual circumstances and all tax rules may change in the future. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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