“Of course, the opposite to this scenario is also true, and you would seek out longer dated bonds where you may be able to pick up some higher yield.”
He cautions: “However, the outlook for bond markets remains uncertain, although the backdrop does appear to be moving into a new phase. Having experienced several years of low growth and low inflation, combined with monetary stimulus and emergency interest rates, you could have invested anywhere in bond markets over the last eight years or so and you would have received equity-type total returns.
“Investors should not expect this to continue. Inflation numbers are ticking up, economic growth is proving robust and the US has already started on a rising interest rate cycle.”
Both US and UK central banks are trying to keep a lid on inflation. Having targeted 2 per cent inflation respectively for the past few years, the Federal Reserve and the Bank of England (BoE) are adjusting interest rates higher to contain the inflationary environment.
The US Federal Reserve has only raised interest rates three times since 2008, with the latest move in March this year taking the base rate from 0.75 per cent to 1 per cent.
Meanwhile, in the UK the BoE held the base rate at 0.25 per cent in March, although CPI inflation picked up to reach 2.7 per cent in April – its highest level in 2013 and exceeding the bank’s target.
Up the curve
Nicolas Trindade, senior portfolio manager at AXA Investment Managers, believes with the yield curve relatively flat at the moment by historical standards, the pick-up investors can get by going further up the curve is limited.
“Also, with yields set to rise on the back of higher growth and inflation, investors should avoid extending maturities and instead consider adopting a short duration approach,” he adds.
But Martin Horne, head of European high yield investments at Barings, suggests the high yield market has historically adjusted quickly to rising interest rates.
He observes: “Interest rate rises are typically accompanied by robust economic conditions, which in turn lead to spread tightening, a positive catalyst for the pricing environment of fixed rate bonds.
“While the exact timing on interest rate rises appears uncertain, central banks today seem keen to ensure policy movements do not cause negative market disruption, which will likely translate to near-term developed market movements that are proportionate and well-flagged.”
