Bond yields are at multi-year highs, and inflation has appeared to peak in the US, with the focus now on what it would take for the Fed to start cutting rates. Mark Redfearn, Portfolio Manager, PPM America, and Clement Chong, Director, Credit Research, Eastspring Investments, share their insights on US and Asian bond markets, covering valuations, cash rates, bonds as diversifiers, as well as where the opportunities are.Bond yields now in many countries are at multi-year highs, offering investors a once-in-a-decade opportunity to enjoy attractive levels of income and potential capital gains when yields head lower in the coming months and years.
Over the last 13 years, buying US bonds at current levels of around 5.75% has delivered 5-year forward returns of 6% p.a. Historically, there has been very few instances where yields have moved higher from here, suggesting that current yields provide investors with very attractive entry levels.
In the coming months, as both the US economy and inflation slows further, it would not be surprising for bond markets to move ahead of the Fed and for bond yields to start declining even before the Fed’s first rate cut. As such, investors may want to look beyond the current cash rate levels and instead focus on the upside potential of bonds.
Asia’s inflation has been relatively more contained than the US’, as the region has not experienced the same extent of demand-supply imbalances, especially in the labour market. That said, the recent rise in oil and food prices bears monitoring although historically, Asian central banks have shown the willingness to cushion the impact of high oil prices via subsidies.
The resilience of the US economy to date has given the Fed confidence to keep rates high for longer. A faster-than-expected deterioration of the US economy could prompt the Fed to pivot earlier. Asian central banks are more likely to follow the Fed’s lead.
Given current yields, bonds can regain their roles as diversifiers in portfolios again as the income they generate should help buffer portfolios against potential equity market volatility. With the ongoing uncertainty over economic growth, it may be prudent for investors to refocus on income and principal preservation in their portfolios. At current yields, bonds potentially offer equity-like returns but with lower volatility.
In both the US and Asia, Investment Grade credits are expected to better weather the higher costs of funding given their stronger credit profiles. Over in Asia, the yield to worst for Investment Grade credits is at its highest since 2008. This presents the potential for capital appreciation when the Fed starts to pivot.
Historically, IPOs have also appealed to retail investor for their alpha generation potential. Our analysis shows that IPOs historically demonstrate positive excess returns over the market. We see a similar phenomenon when looking at longer-term excess returns from participating in IPOs for the same markets.
In Asia, there is a preference for local government bonds, especially from countries that have stronger fiscal and current account positions, better inflation dynamics and the flexibility to cut rates at some point. Since Asian currencies may be weighed down in the near term by a weak RMB, it may be appropriate to assess valuations on a currency-hedged basis.
