2Q 2021 bonds: where are the opportunities as inflation looms?
We explore the bond themes and opportunities 2Q 2021 as inflation picks up.
As the global economy is gradually recovering from the fallout of the global public health crisis, interest rates are expected to stay low for longer to sustain economic activities. Currently, the search of income could be likened to a triathlon, and adopting a consistent yet flexible investment approach is essential.
After the onset of the global public health crisis and the financial market lows in March, global central banks and governments have responded with monetary and fiscal policies that are unprecedented in size, timing and coordination.
The amount of US Treasury purchased by the Federal Reserve between mid-March 2020 and mid-June 2020 accounted for about 8% of American gross domestic product, the highest share ever since the US rolled out the first round of quantitative easing during the global financial crisis in 20081.
US Treasury stood out among major fixed income sectors in the first quarter of 2020 with a return of 8.2%, followed by developed market government bonds which returned 3.1%.
In addition to traditional US Treasury and government bonds, there are also other riskier fixed income assets that could offer relatively attractive yield and return opportunities.
High-yield (HY) corporate bonds3, for example, underperformed in the first quarter after a liquidity crisis. But in the third quarter, European HY bonds took the top spot from US Treasury with a return of 7.1% as market sentiment stabilised. Other HY sectors also rebounded in the second quarter with US HY and Asia HY ranked second and third, respectively.
Low correlation drives diversification
The fixed income universe comprises diverse sectors, and their performance could vary as different factors come into play, including interest rate risk, credit risk, sovereign risk and liquidity risk.
Extended fixed income sectors such as MBS and ABS have underlying assets which are mostly loans extended to individuals, setting them apart from corporate bonds which are closely tied to company balance sheets. As MBS and ABS are tapping into the balance sheets of consumers, these extended sectors have lower correlation to corporate bonds.
A diversified fixed income strategy investing across sectors with lower or negative correlation could help broaden income and return potential while managing portfolio volatility.
Yields and correlations of fixed income sectors4
Seeking yield as rates stay low5
In uncertain times, adopting a diversified fixed income approach that integrates traditional and extended fixed income sectors could help broaden income and return opportunities while managing portfolio volatility.