| Total Returns in US Dollars | ||||
| Drawdown Dates | Event | S&P 500 Total Return |
Global Investment Grade Bonds* |
Global Government Bonds** |
|---|---|---|---|---|
| 21/09/2018 to 21/12/2018 |
2018 Rate Hiking Cycle | -7.5% | 0.0% | +1.9% |
| 14/02/2020 to 23/03/2020 |
2020 COVID Crisis | -24.8% | -8.0% | +1.5% |
| 15/02/2023 to 13/03/2023 |
2023 mini banking Crisis |
-7.0% | +0.2% | +1.4% |
| 12/07/2024 to 05/08/2024 |
2024 US weakening economic growth | -8.0% | +1.3% | +2.0% |
Fixed income
A New Beginning: Bond Investors Poised for Fresh Opportunities
7 min read 14 Oct 24
The US Federal Reserve (the Fed) decided to take a big step towards normalising monetary policy in September, with a jumbo sized 50bps cut. Given the significant stresses that bond investors have been through over the last 5 years, this action represents an important milestone, and is a strong indication that the global inflationary episode is gradually moving behind us.
For the Fed, this effectively means that the focus has shifted from the 2% inflation target towards the labour markets and economic growth, where recently the data has been weaker. Will US economic growth stabilize at current levels (around 2%), or is the recent downshift in employment gains an indicator of further deterioration to come? In our view, while a soft landing is still very much possible, the combination of weaker economic growth and monetary policy that remains quite tight – despite recent rate cuts – also warrants trading carefully from an investment perspective.
Entering a New Phase: What is Changing?
With inflation nearing the Fed’s 2% target, and the labour market stabilizing, economic conditions are beginning to resemble pre-pandemic norms.
Job creation has slowed and the ratio of job openings to unemployed workers has reverted to 2017-2019 levels. This shift in economic fundamentals has allowed the Fed to begin easing its monetary stance, which brings new considerations for bond investors.
As we enter this new phase, the question remains: What key lessons should bond investors carry forward to ensure success in the future?
Lesson 1: Inflation – The Persistent Challenge
Inflation, which has been subdued for much of the past decade, made a surprising return in 2021 due to post-COVID reopening and supply chain disruptions exacerbated by Russia’s invasion of Ukraine. This was a stark reminder that inflation can quickly resurface when demand outpaces supply.
As the Fed begins cutting interest rates, inflation risks still persist. Central banks, having learned from the inflationary pressures of the past few years, are likely to be more cautious going forward. They are likely to avoid keeping rates too low for too long or engaging in large-scale quantitative easing. For bond investors, it is essential to remain vigilant, as inflation could continue to be a challenge in the coming years.
Lesson 2: Navigating High Government Debt Levels
In the pre-pandemic era of ultra-low interest rates, both public and private sectors were able to accumulate debt with minimal consequences. However, as interest rates has risen, the cost of servicing that debt has increased, placing pressure on governments and corporations alike.
In the US, for example, federal debt has increased from 104% to 120% of GDP over the last five years, and interest payments now account for a larger share of government revenues. This limits fiscal flexibility and makes it more difficult for governments to respond to economic challenges or invest in growth. For bond investors, understanding and assessing which governments and sectors can manage their debt burdens responsibly will be crucial for long-term success.
Lesson 3: Bonds as a Source of Stability
Throughout recent market turbulence, bonds have continued to offer stability and consistency in otherwise volatile market conditions. Despite both bonds and equities delivering negative returns in 2022 due to aggressive rate hikes, high-quality government and corporate bonds have remained a reliable source of diversification.
During key moments of market stress - whether it was the 2018 rate-hiking cycle, the COVID-induced market crash of 2020, the “mini-banking” crisis of March 2023, or the more recent weakening of US weakening economic growth - bonds have held their ground, acting as a stabilizing force when equities faltered. As bond investors enter this new phase, bonds will continue to play a crucial role in providing stability and diversification.
Source: Bloomberg, as of 5 August 2024.
* ICE BofA Global Corporate Bond Index
** ICE BofA Global Government Bond Index
Looking Ahead: Seizing the Opportunities of a New Beginning
The past five years have been challenging for bond investors, marked by inflation spikes, rising debt and market volatility. Now, with interest rate cuts on the horizon, the market environment is set to shift, presenting new opportunities and risks. This new beginning offers bond investors the chance to apply the lessons learned from the past and adapt to changing conditions.
In this new phase, flexibility and strategic thinking will be key. Investors must remain agile, adapting to changing conditions, managing inflation risks and navigating the complex landscape of debt sustainability, and making careful choices to capture the opportunities that lie ahead. The future is full of potential for those who remain proactive and adaptable in the evolving investment landscape.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance.