Bond Compass: Searching for Yield in a Sea of Low Rates
The reflation trade remains the dominant theme in the market, despite renewed lockdowns, with the vaccine rollout expected to result in a rebound in growth in 2021. The more favourable backdrop for risk assets coupled with low, or even negative, yields for much of the fixed income universe is likely to see investors searching for higher yielding assets.
For fixed income investors, 2021 should be about searching for yielding assets. Emerging markets (EM) provide yield of around 3.5% and may benefit as a return by investors to EM debt, which started in 2020, gathers pace.
Local currency debt should benefit given the potential for EM forex appreciation to add to bond returns with the USD weakening trend expected to remain in place.
The global investor underweight to Chinese bonds could see inflows continuing.
Capitalising on the Growth Rebound
The widespread vaccination programs already underway, coupled with fiscal stimulus, should allow growth in developed economies to rebound in 2021. Solid growth and rock-bottom rates could support risk assets such as high yield.
Alternatively, convertibles look like an effective way to capture growth upside. They do not provide high levels of yield but could post strong gains if equity markets continue to rise.
Convertibles typically have lower default risk than high yield bonds and can act as a diversifier for fixed income portfolios.
The Inflation Question
Since the Global Financial Crisis, inflation has never really reared its head – but its shadow still stalks investors’ minds. The degree to which it picks up is a key question for 2021.
US markets have moved to price in higher inflation and, with 10-year break-evens at over 2%, much of the move has already been priced in. That said, risks still look to the upside and investors concerned over this prospect can consider TIPS.
EMs look less well protected. The PriceStats® indicator highlights considerable upside risks to inflation but break-evens on the Bloomberg Barclays EM Inflation Linked 20% Capped Index have remained in a range for the past six months.
Bond Compass Overview with Jason Simpson, Senior Fixed Income ETF Strategist
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