‘Follow-the-Fed’ trade may be at an end says JPM’s Eigen

Traditional bond managers now spend their time “parsing” the words of the world’s central bankers, but that may soon come undone, JP Morgan’s Bill Eigen says.

Tight credit spreads are making all bond sectors move in lock-step, while diverging monetary policy is driving volatility up, the manager of the JP Morgan Income Opportunity fund says.

“Risk is on the rise and investors may be too complacent about their exposure to potential interest rate risk,” he warns.

“With the US Federal Reserve prolonging the day of reckoning by refusing to raise rates despite the decent US economy, the ‘follow-the-Fed’ investment strategy won’t work forever.”

His $7.9bn (£5bn) fund has 56.4 per cent cash at the moment as he worries about the “increasingly thin” margin of safety in bond prices.

Unlike the 1994 sell off in bond markets, coupons are much smaller today which leaves less cushion for rising rates to gobble up capital.

“In other words, even a marginal rise in interest rates could wipe out significant coupon income,” Eigen says.

Compressed yields are near historic lows which is making it difficult for managers to provide a reasonable total return, he adds.

“Global economic and monetary policy divergence is becoming stark. As the US economy is recovering quite well, the de-synchronisation with regions like Europe and Japan is evident. This will cause some market distortions. Bond market volatility is certain to increase.”

Much smaller dealer inventories will also stretch liquidity, especially in high yield, convertibles and loans.

“Correlations across sectors of fixed income have increased in the last few years. The tighter spreads become and the lower rates go, the more that the different sectors move in lock-step,” he says.