With the US Federal Reserve normalising monetary policy through rate hikes and balance sheet reduction, some investors may wonder: Why hold fixed income at all considering the challenging outlook?
We think there are still compelling reasons:
- Not all fixed income sectors respond the same way to a rising rate environment. For example, long-dated US Treasury bonds tend to decline most sharply when rates rise, shorter-dated Treasuries less so.
- Some higher risk sectors are likely to hold up well during rate hikes. For instance, the large coupons on offer in areas outside US government bonds can help offset price declines on a total return basis. Default risk should be low when growth is strong.
- Diversification in fixed income portfolios is critical in the current rising yield and volatile environment. It is likely that monetary policy divergence between the US and other countries will continue. Diversifying internationally can better position an investor's portfolio for tighter US monetary policy.
- Seeking downside risk mitigation to an overall portfolio is another reason for staying invested in fixed income. In an environment in which risk assets may underperform, investors may turn to core fixed income.
Correlation of sectors to US 10-year Treasury
Source: Bloomberg, Barclays, FactSet, J.P. Morgan Asset Management. US treasuries are represented by Bloomberg Barclays Global US Treasury Total Return Index, Global ex-US government is represented by ICE BAML Global Government ex-US Total Return Index, EMD ($) is represented by J.P. Morgan EMBIG Diversified Index, EMD Corporate is represented by J.P. Morgan CEMBI Broad Diversified Index, EMD (Local) is represented by J.P. Morgan GBI EM Global Diversified Index, Euro Corporate is represented by Barclays Euro Aggregate Corporate Index, and Euro high yield is represented by Barclays Pan-European High Yield Index. Correlations are based on 10 years of monthly returns for all sectors. Data as of 30.04.2018.