During the last few years, low inflation, moderate economic growth and quantitative easing have kept interest rates across the yield curve relatively low within the European and US markets. Fund managers might be wondering when the Federal Reserve might increase interest rates. One might also argue whether it will take another decade to experience a rate hike.

It all started way back between the years 2006-2015 where we have seen the global economy going through the financial crises and the consequential recession. It was November 2008 when the US Federal Reserve (Fed) started adopting monetary policy measures involving rate cuts and the introduction of the quantitative easing (QE) programme, which aided in stimulating the economy by literally having money pumped into the economy through treasury stock purchases. At this point there was no turning back, and yields have gone down reaching historic record low levels.

After seven years of austerity measures in the Euro Area, the European Central Bank followed suit, adopting a quantitative easing programme in January 2015. All of this combined with the u-turn taken by the US Federal reserve to a more dovish tone (arguments favouring rate cuts) since more than a year ago led to further price appreciation across the board, as yields bottomed once again.  2019 was in fact one of the best years for the bond markets, while at the same time we experienced strong-double-digit gains across the equity markets.

Traders are currently forecasting a rate cut by the Fed possibly towards the end of the year despite minutes by the Fed last December signalling no plans to change rates in 2020. Even so, earlier this week at the annual World Economic Forum event in Davos, US President Donald Trump continued to criticize the Fed for its monetary policies. Trump is in fact inclined towards a negative interest rate environment in the US, such as to help his nation compete with other nations where borrowing money is not costing them anything.

Getting a closer look at the yield curve environment so far in January, one would note that the recent political turmoil between the US and Iran has shifted investors slightly towards fixed income securities. Such a market sentiment has resulted into lower yields as bond prices traded higher. On the other hand, this had minimal impact on the US equity market, which remained bullish following also phase one of the trade agreement reached between China and the US.

Moreover, following the first case of Coronavirus in the US, the 10-year treasury yields have slipped to a seven-week low seeing investors shifting to safe haven assets. Investors are raising concerns whether this virus will have the same impact of SARS witnessed way back in 2002 where we had seen the Chinese economy slowing down.  Then again, “the reaction in markets suggests that the virus fears aren’t necessarily going to be the main story…not enough that good news wouldn’t break through and help them reduce losses” according to Connor Campbell, analyst at British financial spread better, Spreadex.

Bond prices have also rallied within the Eurozone, as bond sales increased, factoring in policies that the European Central Bank president, Christine Lagarde, intends to sustain through the buying of €20 billion worth of bonds per month. Investors in general are predicting that interest rates will remain at these levels for the foreseeable future, albeit economists are of the opinion that the outlook for the Eurozone has somehow brightened.

Such rate stability might trigger investors to move away from developed markets within the euro area, which are currently resulting in a negative yield, and look at the higher-end of the risk-spectrum, such as emerging market bonds, where the 10-year yields currently revolve around the 3% mark or higher. Given the positive approach Christine Lagarde showed during her first monetary policy meeting last December, where she highlighted signs of economic stabilisation in the Eurozone and positive sentiment within investors, the equity market continued to rally. It is interesting to note that even though the equity market is considered to be at an all-time high, bond prices have at the same time continued to trade higher, resulting in low and negative yields.

A similar scenario can be seen with regards to the UK market following the strong vote to affirm Boris Johnson in government, where we have seen the 10-year government bond yield increasing to a six-month high as investors considered riskier securities. Since then, yields have remained low with the equity market slightly unchanged following final negotiations with the EU to complete Brexit.

All in all, it will be interesting to observe whether and by how much yields will be impacted when tariffs and Brexit-related issues are resolved.

Given the current market trend, being selective is key. We are currently experiencing modest growth and a low inflationary environment on a global level. This seems to imply that rate cuts will not be reversed anytime soon. Limited supply of bonds against strong demand, have also moved valuations higher. Monetary and fiscal stimulus which is currently being injected in the US and global economies will mitigate the possibility of an economic recession. Even though yields across good quality bonds are expected to remain low, they should still play an important role in one’s portfolio.

 

Matthew Magro is a team member of Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]