Bond yields spike globally: What should be your fixed income strategy?

Growing inflation fears and expectations of monetary tightening by central bankers due to the spike in global oil prices are among the key drivers of the yields.

The bond market is making headlines as yields have spiked to multi-decade highs globally, sparking a risk-off sentiment. But the sharp rise in yields is also throwing up opportunities for fixed-income investors to lock in attractive returns, with fund managers favouring the shorter end of the curve amid expectations of further rate hikes.

 

The yield on 10-year US Treasury notes rose to ​a near three-year high of 4.81 per cent. Japan's 10-year yield was perched above 3 per cent, a 30-year high, and Australia's ‌10-year government bond yield rose to 5.198 per cent, its highest level in over 15 years, according to a Reuters report. 

 

 

Back home, the yield on India's 10-year government bond also rose 4 basis points to 7 per cent in Wednesday's session, touching its highest level in three months. 

 

Growing inflation fears and expectations of monetary tightening by the central bankers due to the spike in global oil prices are among key drivers of the yields. Brent futures topped the $96 per barrel mark as supply disruption fears strengthened following a fresh exchange of fire between the US and Iran.

 

Sandeep Bagla, CEO of Trust Mutual Funds, said that the main reason for the rise in bond yields is the expectations of higher inflation going forward. Other big reasons are commodity price increases globally and loose monetary policy and low interest rates, he said. "In the US, the central bank has been supporting economic activity, and interest rates have been too low for too long."

 

Inflation rate in the US came in at 3.4 per cent in July but remains above the US Fed's comfort band of 2 per cent.

 

Avnish Jain, CIO - debt, Canara Robeco MF, said the other concern is fiscal deficits across advanced economies. "The US, in particular, is running a huge fiscal deficit of around 6 per cent. Japan is also seeing higher rates because of fiscal concerns. Even the European Union is likely to move towards a higher fiscal deficit because of increased defence expenditure." 

  

Back home, the Indian debt market is currently pricing in around 75 basis points of rate hikes, which is reflected in current yield levels, said Murthy Nagarajan, head – fixed Income, Tata Asset Management. 

 

Strategy for fixed income investors

Nagarajan believes that at the current yield levels, low-duration funds continue to offer carry above 7 per cent, while duration products are offering yields above 7.5 per cent, making current levels attractive for investors.

 

Bagla said that the strategy should be at the lower end of the curve, which is in India, two- to three-year corporate bonds of high quality, where the spreads are attractive, in anticipation of rate hikes. "These bonds can also be safe in the sense that, as time passes, the maturity of these bonds will come down. They will start trading at a lower end of the yield curve as the maturity approaches, protecting the investor," he added.

 

Piyush Baranwal, director - senior fund manager, WhiteOak Capital Mutual Fund, highlighted that the demand for G-secs has been muted in recent years. "Pension funds were also less active last year amid asset-allocation changes, while this year, although demand may improve, the supply remains high. FPI demand for long-term Indian bonds has also been weak. This year, with liquidity more comfortable due to FCNR inflows, large-scale RBI buying is unlikely, adding to demand-supply concerns," he added.

 

Against this backdrop, he remains cautious on the long end of the curve, particularly 10-, 15- and 30-year bonds. "If yields rise materially, they could become attractive, but at current levels, I would prefer the shorter end, around two to four years, where the risk-reward is better."

 

Echoing similar views, Jain said that if somebody wants to look at a fund with around one to two years of duration, or if they are looking at ultra-short-term or low-duration funds, those are attractive in terms of carry and have lower risk from interest-rate movements.

 

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