Market attractiveness bonds: hedging tool against periods of stress
Luxembourg, 12 January 2021 – Investment grade government bonds continue to be a suitable tool to protect against periods of stress on the markets. “As a yield driver, however, they will not be the prime choice in 2021 either”, said Carsten Gerlinger, Vice President of Moventum AM.
“If all the adopted monetary and fiscal policy measures are implemented, this will positively impact global economic growth well beyond 2021”, Gerlinger pointed out. And in the USA, for example, additional fiscal policy support measures are in the pipeline. Central banks also announced to continue or, where necessary, to reinforce their expansionary monetary policy. The outlook for the global economy, which could enter a new economic cycle, is therefore positive.
Inflation rates are also set to approach central bank targets this year: Covid-19 and the drop in oil prices had pushed inflation slightly below zero. “It shows, however, that the adopted fiscal and monetary policy programmes are not leading to fundamental inflation of the price of goods, but rather to asset price inflation (bonds, real estate, equities)”, Gerlinger explained. In 2021, base effects such as the higher oil price, the CO2 tax in Europe and the renewed increase of the value-added tax in Germany will take effect and cause inflation to rise towards previous central bank targets. “In the US, even inflation rates of just over two per cent are possible”, Gerlinger highlighted.
In terms of portfolio construction, this means that Bunds will be unattractive in the context of the 2021 economic scenario. “We think that price gains will only be possible in the event of increased risks”, said Gerlinger. Consequently, bonds are only suitable as a hedging tool against phases of stress. While government bonds from peripheral countries continue to offer a yield premium, the risk premium is relatively low. “As in the US, we expect the yield curve for German government bonds to steepen slightly at the long end. In absolute terms, yield levels will remain unattractive”, Gerlinger added.
The situation is similar in the USA: New US President Biden stands for high government spending and thus for elevated government debt. “We expect yields to rise to just over one per cent at the long end”, Gerlinger said. “This will lead to steepening of the yield curve. At the short end, rates will remain stable at the very low level.” Market participants do not expect initial rate moves prior to 2023, with some even expecting them closer to 2025. Should there be a sharper rise in yields to well above one per cent on 10-years, it is possible that, along Japanese lines, the Fed will directly steer the yield curve. According to Gerlinger, “there is no doubt about US government bonds as being a first-class tool to protect against periods of stress”.
US high yields are hedged by the Federal Reserve’s announcement that it will also buy such bonds as part of its bond-buying programme. Volatility will remain high, while timing will remain ambitious. “In bond picking, this is where you separate the wheat from the chaff”, Gerlinger stressed. “Just like corporates, high yields have lost a lot of their attractiveness due to the tightened spread. Both segments are now only hold positions”, Gerlinger cautioned.
Emerging market bonds will largely be influenced by the development of the US dollar and US interest rates, with correspondingly high correlation with the US segment. Bonds issued in hard currencies are benefiting from the friendly Fed policy, while spreads versus high yields and investment grade bonds are still attracting investors. Falling oil prices and interest rate cuts could have a negative impact, but are not yet foreseeable. “We continue to favour hard-currency bonds and specifically the Asia region”, Gerlinger concluded.
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