2. Lower-for-longer interest rates
 

In response to the COVID-19 pandemic, central banks and governments have rolled out monetary and fiscal support unprecedented in size, timing and coordination - driving rates lower for longer. In March 2020, the Reserve Bank of Australia (RBA) cut its cash rate two times to a record low of 0.25%. It also rolled out various measures to provide cheap funding to support corporates. The RBA remains committed to supporting the economy and further easing may occur in the coming months.

Looking forward, rates are likely to stay lower for longer as the US Federal Reserve (the Fed) announced in September 2020 a shift in focus to target an average inflation level of 2% over time. After years of failing to reach its inflation mandate, the Fed is prepared to tolerate higher rates of inflation before raising interest rates to ensure an average inflation of 2%.

This pushes any expectation of a rate hike by the Fed well beyond the 2023 date priced by the market. It also means that other central banks, including the RBA, are unlikely to be able to raise their rates if the Fed doesn’t, given the impact it could cause currencies to further appreciate against the US dollar. As real rates and real yields are expected to remain negative for some time, this would further limit the appeal of core government bonds.
 

25% of the global bond market are negative yielding 

Source: Bloomberg Barclays, BofA/Merrill Lynch, FactSet, J.P. Morgan Asset Management. For illustrative purposes only. Guide to the Markets – Australia. Data as of 30.09.2020.

Solution: Benefit from multiple income sources
 

Yield^{^^} can still be found, but may require an unconstrained approach to identify the high-conviction investing ideas. There are various types of bonds globally and they react differently to market changes such as interest rate movement and economic cycle. When managed properly, this could also mean added diversification^{^} in portfolios if alternative asset classes are included.

Source: Bank of America Merrill Lynch, Bloomberg Finance L.P., FactSet, ICE, J.P. Morgan Economics Research, MSCI, J.P. Morgan Asset Management.
Based on Bloomberg Barclays US Treasury (UST) Bellwether 2y & 10y (2y & 10y UST), Bloomberg Barclays Treasury Inflation-Protected Securities (TIPS), ICE BofAML Country Government (1-10y) (Australia, Germany, Japan & UK (1-10y)), Bloomberg Barclays US Aggregate, Credit – Investment Grade & High Yield (US Aggregate, IG & HY), Bloomberg Barclays US Floating Rate (US Floating Rate), Bloomberg Barclays US Aggregate Securitized – Mortgage-Backed Securities (US MBS), Bloomberg Barclays Pan-European High Yield (Europe HY), J.P. Morgan GBI-EM Global (Local EMD), J.P. Morgan EMBI Global (USD EMD), J.P. Morgan Asia Credit (JACI) (USD Asia Credit), J.P. Morgan Asia Credit (JACI) – High Yield (USD Asia HY), J.P. Morgan CEMBI (USD EM Corporate Credit), J.P. Morgan Asia Diversified (JADE) (Local Asia). *Correlations are based on 10-years of monthly returns. Guide to the Markets – Australia. Data as of 30.09.2020.

KEY LEARNINGS

Market volatility and lower yields^{^^} are expected to stay. It’s time to embrace the challenges, differentiate and invest where opportunities can be found via an unconstrained and flexible approach.

^Diversification does not guarantee investment return and does not eliminate the risk of loss.
^^ Yield is not guaranteed. Positive yield does not imply positive return.

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