Temper tantrums in the bond markets

2018 has started off with far more volatility than the placid 2017. Big moves in the bond markets have seen government bond yields spike sharply worldwide. The ‘Bond King’, Bill Gross – fund manager at Janus Henderson – has already labelled it a bear market.

Volatile start for the 2018 bond markets

This volatility has been pinned on press speculation that Chinese authorities might slow down or stop their purchases of US Treasuries (US Government bonds) for the purposes of China’s foreign currency reserves. This was possibly a warning to President Trump, who recently criticised ‘China’s unfair trade practices’ again and once more threatened protectionism. Chinese officials, in the style of President Trump, have snubbed this as ‘fake news’.

Changes at the Bank of Japan

Markets also appear to be alarmed by news that the Bank of Japan has slightly changed its quantitative easing strategy. Although it has maintained its overall level of monthly purchases, it has reduced support for longer-dated bonds, signalling a tolerance for higher longer-term borrowing costs. While the US Federal Reserve, Bank of China and the Bank of England are already in rate hiking mode to various degrees, the Bank of Japan had been seen as the major authority expected to keep its foot firmly on the accelerator and therefore continues to be the key provider of cheap money. In the current environment, even a small adjustment to activity at the Bank of Japan has unsettled the markets.

Bond markets may no longer be a ‘safe haven’

These things show how skittish bond markets can become when Central banks across the globe slowly withdraw the liquidity they provided in the aftermath of a global financial crisis. It also serves as a warning that, in such a phase, bond markets may not be quite the ‘safe haven’ they have traditionally been perceived as.

Ironically, the latest fund sales data release from the UK’s Investment Association showed that private investors bought into bond funds heavily in the latter part of 2017. Bonds were the best-selling asset class of November 2017 with inflows of more than £2 billion. The continuation of low UK interest rates is likely to have driven this for the large part, but it is compounded by elevated levels of inflation – Consumer Price Index inflation recently hit 3%. This will be driving income-starved investors up the risk spectrum in a quest for elusive yields.

Investment options

In our view, equities are more appealing than bonds on a relative basis – despite stock market valuations being historically high compared to longer term trends in some areas. In the current environment we have a preference for Emerging Markets and European equities.

For more cautious investors with a medium-term horizon, targeted absolute return funds are another option to consider. They use a wide range of investment tools to try to deliver positive returns (over the medium term) that are less sensitive to the overall direction of the markets than traditional funds. Though they are not cure-alls or guaranteed to retain positive results over all time periods – as nothing is – they can help to provide an ISA or a SIPP portfolio with lower volatility.

For more information or if you have any questions about your investments please get in touch by calling 020 7189 9999 or emailing contact@tilney.co.uk.