The bond market has struggled with a heavy dose of indigestion as bond yields rose through the quarter. The chart shows that apart from the high yield market, most of the fixed income world has posted losses. Government bonds, both conventional and linkers, fared worst as they are longer duration assets (simplistically, more sensitive to movement of bond yields in either direction).
Some perspective here is also valuable. Good news on the vaccine front, the passage of the US fiscal package, the rise in growth and inflation expectations have “only” taken the US 10-year yield to levels similar to those of the beginning of 2020, or pre-pandemic. The negative returns found year to date reflect a clawback of elevated levels of positive returns in 2020.
The biggest risk to financial markets is a rapidly rising US Treasury yield and central banks will be keen to assert a calming voice and manage the pace of yields rising. The outlook for the rest of the year is likely to be for yields to gradually move higher and curves to continue steepening. This is unlikely to be a continuous process and there will be periods of consolidation. We remain in a yield starved world and there will be a point where yield rise, in particular those of US Treasuries, and become relatively attractive again to investors. In a relative game, a US 10 year at 1.7%, whilst Japanese 10 years are essentially 0% and German 10 years -0.3% and foreign investor interest in the US Treasury market can be piqued.
Whilst the relative attractiveness of credit has declined over the course of the last 12 month as spreads declined, our continued preference is to allocate to investment grade credit or strategic bond funds. We are nervous of long duration government bonds and have sought shelter in a number of short-dated fixed income funds or strategic bond funds which have some tools to help mitigate against the negative effect of rising bond yields.