In the annals of fixed income investing, 2022 will doubtless go down as an annus horribilis as investors grappled with the sharp rises in interest rates and central banks withdrew the quantitative easing that had propped up bond valuations for more than a decade.
But as 2022 gave way to the new year, the oldest adage of the lot in bond markets – that yields rise as prices fall – took hold, and investors began to creep back into the asset class in order to pick up the income.
Edward Craven, bond investor at Invesco, traces the causes of last year’s rout in the bond markets as the result of central banks underestimating inflation, and then having to react very rapidly.
That led to bonds selling off very quickly.
As the new year hangovers faded from memory, the momentum towards bonds gained further ground as investors begun to prioritise recession protection over inflation protection, creating a desire to own bonds for reasons of capital gain, as well as income accrual.
As we approach the second half of the year, some of the economic data emerging from developed markets has been more positive than expected, but inflation has also been more persistent, bringing into still further light questions around the role of bonds in portfolios.
Bryn Jones, head of fixed income at Rathbones, says: “Last year being underweight duration was the key call for bond investors to get right.
"That would be expected to recede if a recession comes, but what we have seen so far is a strange combination: inflation has stayed high, which is usually what would make an investor go short duration, but economic growth has been OK. But I think in the next six months you are going to see some sort of slowdown.”
A feature of much of the economic commentary right now is the notion that we could have an earnings recession, that is, company profits slip to levels commensurate with an actual recession, but the wider economy avoids this fate.
Jones says that while he expects a slowdown, he is unsure how broad-based it will be, but is staying “in safer waters” for now.
To him that means owning long-duration government bonds, as those assets would usually expect to rise in value as “safe havens” in the event of a deep economic downturn.
But in the corporate bond universe, he is focused on shorter duration assets, as he can pick up decent yields and the bonds may have matured before any downturn occurs.
Paul Grainger, global head of fixed income and rates at Schroders, says as the US was the first economy to begin materially increasing interest rates, the key for investors is to look at what happens there.
