The rapid repricing of government bonds seen since the end of summer has largely been built on the back of investors urgently repricing their expectations around the extent to which interest rates can be cut and inflation can fall in the current market conditions.
But if we are entering a world of higher for longer, its a place that is very different to the landscape many advisers, wealth managers and their clients have become accustomed to, as the period between the end of the global financial crisis and the Covid-19 pandemic was marked by low rates and low inflation.
Philip Collins, chief investment officer at Sarasin, says the world with which investors are now contending “is actually more typical than what went before; what went before, with interest rates at or near zero, that was abnormal on a multi-decade view. If you go back to the 1990s, interest rates tended to be between 4 and 8 per cent.”
Collins says what may be a different challenge for investment managers this time is that, for much of the 90s and in other periods of history where inflation and interest rates were high, it was a sign that economic growth was robust, but that is not the case now, with inflation potentially remaining high even as the outlook for economic growth declines.
That dilemma has recently been represented in bond markets as investors have sold-off the long end of the yield curve, which tends to be the asset class that performs bets in a recession, while owning the short end.
Collins view is that long-dated gilts are not that attractive right now, “because I don’t think we will get much of a recession, and I would rather own cash, which yields 5 per cent, than gilts”.
Chris Iggo, chief investment officer for core investments at Axa Investment Managers, says the present heightened volatility in markets is a function of “investors navigating the change from one era to another – when that happens there is always likely to be volatility.
"One of the characteristics of the previous era is that bonds yielded hardly anything at all, and that meant a lot of portfolio construction involved chasing yield. But with bond yields at the present levels, bonds are more attractive than in the past.
"The issue is, though, that markets are struggling to understand where inflation will settle, they are struggling to understand what the neutral rate of interest is.
"And from a portfolio construction perspective, the challenge is that bonds are not selling off because growth has been better than expected, although it has been, bonds are selling off because the level of issuance has been high, particularly in the US, and there are concerns about inflation.”
Guy Miller, chief market strategist and head of macroeconomics at Zurich, says the present spike in bond yields has been coming for some time, with Chinese and Japanese investors selling, “as well as the realisation that bond issuance is staying higher for longer".
