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Audience

After the crash: where next for global bonds?

09/04/2020

We are witness to nothing less than the greatest short-term hit to demand in economic history.

The advent of isolation across most of the developed world to tackle the coronavirus pandemic has seen an almost absolute drop in discretionary consumer spending. Many companies have seen their incomes fall to zero, as will millions of workers. The second quarter of 2020 looks certain to be the worst ever for economic growth.

Yet there are positive signs, not least from China and Singapore where isolation measures are being unwound. There are reasons to be encouraged too by the development of tests and vaccines for the virus.

So, with most investment assets having sold off so sharply in March 2020, is now the time to take a more optimistic long-term view?

Has the market turned too pessimistic?

The past couple of months have of course been a shock. When we cannot know how much worse the impact of coronavirus will be, mass aversion to investment risk – reflected in the recent price falls of company shares and corporate bonds – is perhaps understandable. But investors’ fears can be overdone, and assets can be oversold.

There will, of course, be a rise in companies defaulting on their debts this year, leaving their bondholders worse off, but will several times more companies fail in 2020 than ever before? Looking at the corporate bond market as a whole, prices indicate that investors’ expectations are that pessimistic.

Yet with falling prices having pushed up yields – the prospective annual income from a bond as a proportion of its price – on corporate bonds to levels not seen, in many cases, since the global financial crisis, I believe there are reasons to take an optimistic medium-term outlook.

In response to the current challenge, central banks including the US Federal Reserve, the European Central Bank and the Bank of England have committed to buy corporate bonds as part of quantitative easing (QE). By doing so, they hope to support companies and encourage investment elsewhere in the economy, and thereby support economic growth.

Alongside this support from central banks is a boost from government policy. I expect the financial help being given to households and businesses, as well as extra spending on healthcare among other things, to be very supportive of economic growth – and of companies – once societies reopen.

Are government bond yields going to rise?

To pay for this fiscal boost, governments are going to have to borrow vast sums. Other things being equal, we would expect a greater supply of government bonds to put downward pressure on their price, pushing their yields up over time.

There are powerful forces that have been pulling government bond yields down over the long-term, however. The megatrends of demographics, globalisation and low inflation have each contributed to the decline in yields over the past three decades. Central bank purchases through QE have had an added suppressive effect.

Recent investor demand for developed market bonds, not least those issued by the likes of the German and US governments, has pushed their yields down further to record lows. Yields are negative in many cases.

This short-term demand driven by their perceived ‘safe haven’ status during turbulent periods, owing to the unlikelihood of default, may wind down as and when the global economy reopens. But over the longer term, the structural trends above seem unlikely to unwind, making it likely that mainstream government bond yields will remain low.

Therefore, while there are indications that yields on these bonds should not go much lower, I do not expect them to go up dramatically either. Investors should be careful betting against them.

Past performance is not a guide to future performance.

The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.

The views expressed in this document should not be taken as a recommendation, advice or forecast.


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