Henderson: The game changer fuelling the global grab for yield

Barnard, Jenna_700x450

Along with other assets, fixed income markets have endured a volatile time so far this year. A major sell-off in corporate bond markets in the early part was followed by an equally fierce rally afterwards, which, at the time of writing, is still playing out.

For investors looking for a catalyst for this turnaround the European Central Bank has garnered a lot of attention, and rightly so. Its landmark decision to buy investment grade bonds issued by non-bank corporations fundamentally altered the perceived demand/supply balance in this market and led to an enthusiastic response from the corporate bond market in Europe. Pre‑dating this announcement, the rally in the oil price from mid‑February had already provided a huge boost for US credit markets. These have proved particularly sensitive to commodity prices as a result of their generous weightings to the sectors.

With all eyes firmly fixed in the direction of the ECB and oil, however, another development was quietly brewing in the background. While yet to receive sufficient mention, the dramatic drop in Japanese government bond yields has been a game changer.

For some time now, the first thing I look at on my Bloomberg screen every morning has been charts of Japanese government bond yields. The 10- and 30-year yields have dropped from 0.27 per cent and 1.28 per cent respectively at the start of the year to around ‑0.10 per cent and 0.34 per cent at the time of writing. The catalyst for the collapse in yields was the surprise announcement of negative interest rates in late January from the Bank of Japan. Other maturities have also suffered a similar fate: the BoJ’s policy of negative rates has certainly succeeded in squeezing out the yield in the world’s second-largest bond market.

The latest data from various sources, such as trading desks in big investment banks and the US Federal Reserve, the US Treasury and the Ministry of Finance in Japan, paints a picture of Japanese investors disappointed by the negative returns at home increasingly looking to invest into overseas bond markets, particularly in the US. According to the Bank of America Merrill Lynch, demand for US investment grade corporate bonds is so strong that since January daily market updates sent to clients via email have been translated into Japanese.

With yields so low in both Europe and Japan, this is fuelling an increasingly global grab for yield that corporate bond managers must navigate. While the relatively unnoticed Japanese purchases of foreign bonds has been a focus on our desk, we believe the need to continue with stimulus in Europe will persist even longer than the Japan‑led demand. This is because overseas demand is inherently pro- cyclical: higher government bond yields domestically would reduce the push to invest elsewhere.

While we have sympathy with this grab for yield trend, given the backdrop of low growth, low inflation and low yields, the competition to find attractively valued assets with sensible yields continually challenges us as bond managers. The reach for higher yields is well suited to the current low-growth, low-inflation environment and may continue for years to come. However, there are tail risks to be wary of, such as a pick-up in global growth or inflation that can be detrimental to government and investment grade bond returns.

Amid the recent volatility we tried to stay true to our philosophy of investing in “sensible” yields. In corporate bonds this involves investing in large, non‑cyclical industrial businesses that should provide investors with a reliable income stream. In the last year we have generally been adjusting our portfolios, shedding some of the higher-risk assets and finding solid opportunities in the US investment grade market. These included long maturity bonds of telecom and tobacco industries with yields of 5 per cent on 30‑year bonds and 4 per cent on 10‑year bonds.

Jenna Barnard is co-head of strategic fixed income at Henderson Global Investors