Bond markets are demanding care in a brave new world
Unprecedented is a word that is often overused, yet it is entirely appropriate for what bond markets have experienced in recent years. Through our pension or investment funds, many of us are indirectly invested in the bond markets, representing government and corporate fixed income debt instruments. And the combination of record low interest rates and the quantitative easing we have experienced is, quite literally, unprecedented.
In general, the capital value of a bond increases when interest rates are reducing and falls when interest rates are rising. So when we read about bond yields rising, it is usually not great for the value of bond holdings. Many bonds across a number of world markets have seen a fall in value over the last few weeks.
In the US, May saw the highest wage growth since mid-2013. If this is sustained along with other related economic data, the chances of an early rise in interest rates will increase. However, with the prospect of relatively low growth for a considerable period, those increases may not be overly dramatic.
Of late, bond markets have become more fickle. Last week, Mario Draghi, head of the European Central Bank, said that markets should get used to periods of volatility. With interest rates at historic lows, the real questions are when and by how much interest rates will increase.
For those with flexibility to do so, a greater focus on bonds with a shorter time to maturity would certainly reduce volatility. A selective approach to corporate bonds can also help. Adjustment to direct investments, or indeed the selection of a fund manager that can take more strategic positions in a bond fund may be worth considering.
It is certainly not a time to be overweight in the bond markets, but equally don't forget the value of having a diversified portfolio to include most asset classes, because none of us can be that precise about when or by how much markets are going to move.
Jeremy Stewart is head of wealth management and private banking at Danske Bank