What happened to fixed income?
For more than three decades, the trend of falling yields has been a dominant theme in global bond markets. How has Covid-19 affected the outlook for the asset class?
The coronavirus-induced market meltdown in March triggered a flight to bonds, with 10-year Treasury yields plunging to an all-time-low of 0.318% at the beginning of March
Why we are where we
are with bond yields
Plummeting bond yields are not a new phenomenon. Much has happened in the past few decades to take bond yields where they are now.
Their decline began in the late 1980s as a result of falling inflation rates. This, coupled with sluggish economic growth, prompted central banks to relax monetary policy. We look at some key moments
in bonds’ recent history.
What are the trends to influence bonds going forward?
Some secular trends of recent decades are likely
to continue to influence bond yields
Despite falling yields, investors have been pouring more money into bond funds in 2019. Among the reasons for that is fear of global recession, Brexit fears, US-China trade wars and poor economic data.
Flows into bonds over
the past 10 years
Fund flows (bonds vs equities) in 2019 and over the past five years.
Future thinking:
Where to look for yield?
In the wake of the coronavirus crisis, slow growth and economic uncertainties globally could trigger even more central bank policy easing, with additional rate cuts, a surge in negative rates and more QE. Government bond yields could remain low in this environment.
So where should investors look for yield?
The case of EM debt (EMD)
EMD has experienced a strong decade of double-digit returns, despite factors such as geopolitical risks. However, the coronavirus fallout has hit EM debt particularly hard. A possible rise in defaults and debt restructurings has increased the headwinds for the asset class. Will EMD get the same attention from investors in 2020?
Emerging market debt today
In 2019, 40% of global GDP came from EM economies
EM bond market is 23% of the global bond universe
Developed Markets
59.75%
Emerging Markets
40.25%
Developed Markets
77%
Emerging Markets
23%
The structural reasons to like emerging market debt
But what are the risks?
Green bonds
Issuance of green bonds is increasing rapidly in response to stronger investor demand for sustainable investing. Studies also show that there is a higher yield premium for green bonds compared to non-green bonds.
Around $521bn of bonds had been issued as of the end of 2019.*
*The Climate Bonds Initiative
Credit
Many strategic bond funds have loaded up on credit to chase more attractive returns. One of the issues with this is, however, that credit is more correlated to equities, so it might not offer the same degree of protection in down markets.
2001
2008
2009
2010
2012
2012
2015
2016
2018
2019
2019
Sources: Bank of England, Office for Budget Responsibility, Stanford Institute for Economic Policy Research, M&G
2001 - 2006
Japan QE
2009 - 2010
Bank of England began to slash interest rates
and buy bonds
2012
US QE3
2008 - 2010
Federal Reserve starts QE program in the US
2010 - 2011
US QE2
2012 - 2014
US QE4
2015
The European Central Bank starts QE
2018
UK GDP growth is now only around 1.6% a year compared with 2.8% average annual growth in the 50 years to 2007
2016
The 10-year Treasury yield hit an all-time
low of 1.32%
2019
The IMF trims its forecasts for global growth to 3.2%
2019
More than $13tn worth of bonds are offering negative rates
Emerging market fixed income 2019 performance
Source: Statista
2020
2020
March -10-year treasury bond yields hit a new record low of 0.318%.
As weak economies make investors rush for safety, the demand for shoring up money has soared. The resulting stellar rise in bond prices sent yields tumbling, fuelled by the central banks’ response to the coronavirus crisis.
ADD TIMELINE 2
Since the pandemic took hold of financial markets, green bond issuance has taken more of a backseat. According to Morgan Stanley, companies issued 40% less high-grade green debt in April 2020 than in the same month last year.
This became clear during the market turmoil in March. According to MSCI, spreads in credit markets increased during the crisis, while equity prices dropped considerably. A liquidity shock, which prompted a selloff in credit assets, intensified the spread widening additionally.
3 March
11-12
7 April
9
22
4 June
27
Sources: Bank of England, Bank of Japan, Federal Reserve.
3 March
The Fed cuts interest rates by 50 bp.
15 March
The central banks of Europe, the US, Canada, England, Switzerland and Japan take coordinated action to ensure global US dollar liquidity.
23 March
The Fed expands its lending programmes.
11-12 March
The BoE and the ECB announce monetary policy measures to
deal with the
economic blow
of Covid-19.
16-18 March
The BoJ and the ECB ramp up their asset purchasing programmes.
9 April
The Fed provides up to $2.3tn in emergency lending.
7 April
The ECB announces a package of temporary collateral easing measures.
22 April
The ECB takes steps to mitigate the impact of possible rating downgrades on collateral availability.
4 June
The ECB decides
to increase
the pandemic emergency purchase programme by €600bn (£543bn)
to a total of €1,350bn (£1,222bn).
27 April
The Fed expands the scope and duration of the municipal liquidity facility.
15
23
16-18
Asset flows into fixed income funds during the height of Covid-19 in 2020 ($)
Investors have been deeply divided on whether, with negative real returns on 10-year gilts, bonds are still fit for purpose. Here we look at why bonds got to this point and what alternatives are out there for investors.
Source: Morningstar
Note: Unlike index funds, which mimic a broad financial market index to generate returns, non-index funds aim to outperform market returns and are not aligned with a specific index.
2001
2008
2009
2010
2012
2012
2015
2016
2018
2019
2020
2019
2001 - 2006
Japan QE
2009 - 2010
Bank of England began to slash interest rates
and buy bonds
2012
US QE3
2008 - 2010
Federal Reserve starts QE program in the US
2010 - 2011
US QE2
2015
The European Central Bank starts QE
2018
UK GDP growth is now only around 1.6% a year compared with 2.8% average annual growth in the 50 years to 2007
2016
The 10-year Treasury yield hit an all-time
low of 1.32%
2019
The IMF trims its forecasts for global growth to 3.2%
2020
March -10-year treasury bond yields hit a new record low of 0.318%.
2019
More than $13tn worth of bonds are offering negative rates
2012 - 2014
US QE4