Bond market in for reckoning

While bonds have long been heralded as a safe investment and a useful hedging instrument, a global asset manager has cast aspersions on their place in a portfolio looking forward.

Eaton Vance says the bond environment is undergoing a fundamental shift in the US as long-term trends are being scrutinised.

“The US finds itself with about $19 trillion of debt, Treasury yields that are still not far off their lows, a policy focus on growth and inflation, and a dollar that is in the upper end of its valuation range. This doesn’t seem sustainable,” Eaton Vance’s diversified fixed income portfolio manager Henry Peabody said.

“If investors still see fixed income as an integral part of a portfolio, flexibility will be needed and the role of traditional fixed income should be questioned.”

While US bonds have historically been supported by favourable long-term trends, these could soon be threatened, Mr Peabody warned.

“Owing to the dollar's position as reserve currency, the US has been able to consistently expand its balance sheet and lead global growth, while simultaneously lowering interest rates. This has provided bond investors with a generational tailwind of returns,” he explained.

Pointing to the change of US administration, coupled with US policy expectations, Mr Peabody said bond investors should be cautious.

“Treasury yields have risen sharply as investors position for a Trump administration. They are expecting tax cuts, infrastructure spending, less regulation and protectionist policies with the potential for erosion of purchasing power,” he said.

“Further federal balance sheet expansion could continue to pressure rates higher in the long term [and] it looks like the Federal Reserve will have to walk a fine line between offsetting fiscal stimulus and encouraging further strength in the dollar.

“The bond market seems to be anticipating this with interest rates rising sharply and causing investors to reassess expectations, and the role of fixed income in a portfolio.”

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