Bonds Commentary
Previous

Lower Returns, Higher Volatility Likely.

January 2020

While 2019’s returns are hardly indicative of such a backdrop, it is a challenging time to be an investor in fixed income; yields on global sovereign bonds are either negative or below expected inflation, while credit spreads are tight, and ‘relative value’ is the only value to be found. The Bloomberg Barclays Aggregate Bond Index (Agg) turned out an 8.7 percent return in ’19, while the Blomberg Barclays investment grade and high yield corporate bond indices rose 14.5 and 14.3 percent, respectively –a banner year for bond investors! As we’ve noted before, outsized returns for bonds pull forward and decrease future expected returns, while volatility expectations likely must be moved in the opposite direction, setting up a less appealing risk-adjusted return environment as we enter 2020.

The recent air strike in Iraq highlights the continued importance of fixed income diversification in the current environment as those out over their skis reaching for yield via corporate or emerging market bonds have experienced near-term volatility, while investors in longer-term U.S. Treasuries fared better as capital inflows pulled interest rates lower/prices higher as the safety trade took off. Geopolitical flare-ups are increasingly common, with far-reaching and often unforeseen implications for global fixed income markets, as countries thought to be relatively insulated from the fray experience capital inflows or outflows, along with significant currency fluctuations, amid ‘risk on’ and ‘risk off’ portfolio shifts.

Japan comes to mind as just one example. The Japanese economy, in theory, should be largely immune from a U.S./Iran dust-up. However, in the aftermath of the air strike, investors shifted to a ‘risk off’ stance, leading to a flight to safety and a sharp move higher in the Japanese yen and a rally in Japanese Government Bonds (JGBs). Significant yen appreciation is worrisome, as Japan is an export-heavy economy and as the currency appreciates, Japanese goods become more expensive for foreign buyers at the margin. This may prove to be an inconsequential event should fears prove short-lived, but persistent yen strength would have broader implications on global economic growth expectations and dash the hopes of those speculating that manufacturing activity bottomed in the fourth quarter of last year.

The merits of owning long-term U.S. Treasury bonds as part of an investors’ fixed income allocation were on full display early in January. Exposure to longer-term U.S. Treasuries makes sense as part of a diversified portfolio, primarily as an equity hedge given low yields and high durations, but it won’t take much of an inflationary shock or upward surprise on the economic growth front over the coming quarters to generate a negative total return, on paper anyway. Appropriately sizing exposure is crucial.

The consensus among Wall Street strategists entering the new year is that U.S. Treasury yields are anchored and are unlikely move very far from current levels over the course of 2020 with the FOMC on the sidelines and inflation under wraps. While the ‘consensus’ opinion may play out, that doesn’t rule out significant intra-year volatility in interest rates. With rate stagnation being a widely held view, upward revisions to expectations for inflation and/or economic growth over the coming quarters could lead to significant portfolio repositioning and volatility in rates. Relative value remains in asset-backed securities and emerging market debt, but we’re less positive on corporate bonds, broadly speaking, as we enter the new year, and will be looking for opportunities to selectively lower exposure.

Source: Bloomberg, Factset

Next

On a scale from 1 to 5, with 1 being 'Not Good' and 5 being 'Excellent', how would you rate this article?

Press enter to submit your rating

Rate this Article

Use this form to provide additional feedback based on the rating you provided.

Thanks for Rating

Would you like to provide feedback?

Thanks for your feedback!

The content and any portion of this newsletter is for personal use only and may not be reprinted, sold or redistributed without the written consent of Regions Bank. Regions, the Regions logo and other Regions marks are trademarks of Regions Bank. The names and marks of other companies or their services or products may be the trademarks of their owners and are used only to identify such companies or their services or products and not to indicate endorsement or sponsorship of Regions or its services or products. The information and material contained herein is provided solely for general information purposes. Regions does not make any warranty or representation relating to the accuracy, completeness, or timeliness of any information contained in the newsletter and shall not be liable for any damages of any kind relating to such information nor as to the legal, regulatory, financial or tax implications of the matters referred herein. This material is not intended to be investment advice nor is this information intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only current as of the stated date of their issue. Regions Wealth Management is a business group within Regions Bank that provides investment, administrative and trustee services to customers of Regions Bank.

Neither Regions Bank nor Regions Institutional Services (collectively, “Regions”) are registered municipal advisors nor provide advice to municipal entities or obligated persons with respect to municipal financial products or the issuance of municipal securities (including regarding the structure, timing, terms and similar matters concerning municipal financial products or municipal securities issuances) or engage in the solicitation of municipal entities or obligated persons for such services. With respect to this presentation and any other information, materials or communications provided by Regions, (a) Regions is not recommending an action to any municipal entity or obligated person, (b) Regions is not acting as an advisor to any municipal entity or obligated person and does not owe a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of 1934 to any municipal entity or obligated person with respect to such presentation, information, materials or communications, (c) Regions is acting for its own interests, and (d) you should discuss this presentation and any such other information, materials or communications with any and all internal and external advisors and experts that you deem appropriate before acting on this presentation or any such other information, materials or communications.

Employees of Regions Asset Management may have positions in securities or their derivatives that may be mentioned in this report or in their personal accounts. Additionally, affiliated companies may hold positions in the mentioned companies in their portfolios or strategies. The companies mentioned specifically are sample companies, noted for illustrative purposes only. The mention of the companies should not be construed as a recommendation to buy, hold or sell positions in your investment portfolio.

This communication is provided for educational and general marketing purposes only and should not be construed as a recommendation or suggestion as to the advisability of acquiring, holding or disposing of a particular investment, nor should it be construed as a suggestion or indication that the particular investment or investment course of action described herein is appropriate for any specific retirement investor. In providing this communication, Regions is not undertaking to provide impartial investment advice or to give advice in a fiduciary capacity.