Low bond yields: The end of an era?

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With bond yields in the UK and US rising off the back of central bank moves, investors have started to question whether the days of extraordinarily low yields are coming to a close.

In the US, a healthy economic recovery and the Federal Reserve contemplating ’tapering’ its quantitative easing programme has caused an increase in bond yields.

In May 2013, Fed chairman Ben Bernanke admitted the bank would consider easing its $85bn-a-month QE programme if economic data became more positive.

For instance, 10-year bond yields in the US have doubled from their recent lows and are now expected to move about 3 per cent in the next six to 12 months.

Morningstar OBSR investment strategist Andy Brunner says: ”While yields could ease back near term on any disappointment with the US recovery, the long-term trend is for higher yields and probably negative returns in real terms.

”For some considerable time corporate bonds have provided, and still offer, better inherent value given the economic outlook and expected default rates, especially at the riskier end of investment grade and high yield. Even so, investors must be aware that these are very illiquid markets prone to high volatility.”

Brunner adds that emerging market debt appears to be “overowned” and warns that it may take some time for the space to stablise. Emerging market bonds recently saw yields climb after the sector was hit by its worst sell-off in more than a decade.

The strategist also says investors should building equity exposure to companies with exposure to growth markets – “whether be they cyclical, financial or defensive, and irrespective of country, sector and size”.

He adds: “Government and central bank action has helped lower perceived systemic risk and, while a near-term slowing in Fed bond purchases may generate another bout of equity market turbulence, investors are beginning to rebuild equity weightings.

“Yield will remain important in a low interest rate world and higher yielding stocks, albeit only those with growing dividends, remain favoured by investors.”

This increase in US bond yields has also had an impact on debt in the UK, according to Barclays head of equity strategy for Europe William Hobbs, despite the UK market “ignoring” forward guidance by the Bank of England.

Earlier in August, Mark Carney became the first BoE governor to give forward guidance and announced he is unlikely to consider lifting the base rate until unemployment falls to 7 per cent.

Hobbs expects a further increase of UK yields, due to a spillover effect from the US. In recent months, he has also seen a divergence between what the BoE wanted from bond yields and what actually happened.

Hobbs says: “The introduction of the forward rate guidance was meant to send a message to the market that rates should remain on hold until at least mid-2016 . This is what the BoE wished the market to believe. Yet, since the announcement, the UK yield curve has spiked across the term structure, and the market is pricing in a first rate hike one year earlier than indicated by the BoE.

“While we were sceptical about the BoE’s ability to anchor the longer-end yields, the bank has so far not been able to contain the short end of the yield curve either. Clearly, there has been a divergence between the bank’s wishes and reality.”