US$10tn of sovereign credit had yields below zero

Equity markets recovered sharply in the first five months of 2019 leading to the S&P 500 index hitting a new all-time high in early May. This rebound is attributed to the heavy sell off in Q4 and the Fed ending its rate rising and QT policies. This equity recovery spurred a rally in the gilt market with yields falling as investors priced in lower interest rates.

This loose monetary environment, at a time when growth expectations are weak, is encouraging for corporate bonds, hence our maintenance of high yield and investment grade credit. We remain underweight in government bonds.

The inversion of the US Treasury Bond yield curve on the 22nd March did not last for long and while it is seen as a potential indicator of a recession, equities can continue to perform after an inversion if interest rates are expected to fall.

Most of the bond markets adjustments occurred in March when the Fed moved from forecasting three interest rate rises to none and the end of QT. A fall in bond yields created a capital gain in gilts and bonds. Gilts rose by 2% while corporate bonds increased by 3% in Q1. Longer term bonds and index linked gilts performed better because of their extended duration. With inflationary pressures falling, corporate bond yields are looking more attractive.

The easing of monetary conditions saw UK gilt yields fall and German 10-year Bunds return to negative yields. At the end of Q1, an estimated US$ 10tn of sovereign credit had yields below zero meaning investors are paying money to governments to hold their capital.

With interest rates in the US set within the 2.25% – 2.5% range for the time being, the bond market can reassert itself. Over the past decade, declining yields through interest rate reductions have resulted in capital growth having contributed a greater proportion of overall return as compared to yield. In the past year, this proportion has reversed with rising yields.

We see a slowing, but still growing, global economy providing support for bond markets. The interest rate pause from the Fed may be an extended one that puts no pressure on yields or price. We will therefore increase our short-duration corporate bond and extended duration investment-grade bond exposure.

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