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Bonds may appeal as yield hits 3%

David Brenchley  |  27 Apr 2018Text size  Decrease  Increase  |  
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The US 10-year Treasury yield crept above 3 per cent for the first time since 2014 on Wednesday, having threatened this key level for a few months now.

Historically, 3 per cent has been seen as an attractive level for more cautious investors, meaning they are more likely to switch out of risk assets like equities and entrust their savings to the safety of the US Government.

But timing is key. Move too soon and if yields continue to edge higher you’ll lose cash. Bond prices move inversely to the yield, so if the latter is going up, the former is going down.

As with any form of investment, though, timing is not easy. There’s plenty of differing views from investors as to how far the yield can go.

Will The 10-Year Yield Continue To Surge Higher?

Marcelo Assalin, head of emerging market debt at NN Investment Partners, says he has a sanguine view on US interest rates, so he thinks US yields are around fair value currently.

“The more the Fed delivers over the next few years the bigger the likelihood is that the US economy will soft land in 2020, especially after the sugar rush provided by the tax stimulus fades away,” he adds.

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“Therefore, the market should expect the Fed to hold in 2020. So it makes sense the [yield] curve is flat. It makes sense that yields should not be much higher than they currently are.”

That view is backed up by Thomas Flury and Patrik Ryff, strategists at UBS Wealth Management. Rates should end next year between 3 per cent and 3.25 per cent, they say. Therefore, short-term yields are likely to rise more than long-term ones.

David Roberts, head of global fixed income at Liontrust, reckons there’s a decent chance we fall back below the 3 per cent level later today.

Others reckon there’s further to go. Paul Brain, head of fixed income at Newton Investment Management, says he thinks the range will be between 3.1 per cent and 3.4 per cent. According to Philip Smeaton, chief investment officer at Sanlam UK, it could have further to run.

“If bond yields move to establish their long-term link with nominal GDP growth, then 3 per cent may be a brief interlude on the way to 4 per cent,” he predicts. Anthony Willis, investment manager in BMO GAM’s multi-manager team, doesn’t see a rush to 4 per cent. “That would be a genuine surprise and a real shock for markets,” he warns.

Inflation Protection

As Brain expects yields to continue rising, “we think there is nothing magical about the 3 per cent level”. It won’t be until the third or fourth quarter that bonds represent a significant investment opportunity again.

But some do see attractions. Flury and Ryff have an overweight position in 10-year Treasuries versus cash.

Roberts, too, thinks they are “starting to look worth a punt” at this level. “Indeed, US corporate bonds are now paying around 4.5 per cent and that has historically been a decent level to start buying.”

While you’re not going to get rich quickly, he expects a nominal return of close to 50 per cent over the next 10 years from just buying and holding the asset class. It also gives “a lot of protection against inflation, as well as the potential volatility of the stock market”.

Of course, that’s another reason some investors may be waiting for an ideal time to switch from equities into bonds. Volatility was unusually low in 2017 but returned in the first few months of this year.

While current levels of volatility broadly represent a return to normality, investors haven’t taken it too well. That, combined with the fact you can now get 3% in the US Treasury, means for some people equities are not as attractive as they were, according to Willis.

That said, while markets need to get used to the fact that bond yields are edging higher, Willis notes: “It’s been a narrative at the start of every year that bond yields are going up and it’s never really happened at the pace people expected it.”

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David Brenchley is a report for Morningstar in the UK.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

 

is a Reporter for Morningstar.co.uk.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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