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by Vincent WEGHSTEEN
March 16th, 2021 - 4 min read
Impact of rising government bond yields
on your investments in bonds
Higher bond yields have arrived. The 10-year Treasury yield topped 1,50% last week (+0.52% last summer), its highest level in more than a year. The 10-year German Bund topped -0.205% last week, coming from -0.65% in November and the 10-year Belgian Bond topped +0.13% last week, coming from -0.43% end of November 2020.
The expectation remains for yields to keep climbing over coming weeks and months. Since Pfizer/Biontech announced in November that they had a vaccine, the yield curve accelerated its climbing.
The market does expect that with people being vaccinated and the further stimulus aid the pace of global economic reopening will accelerate. A potential spike in inflation could also be around the corner.
Should we fear higher yields?
Most market strategists say investors should expect a challenging yield environment this year as the Federal Reserve and the ECB are expected to keep rates at historically low levels.
As society moves to a post-pandemic world, the outlook for bonds will evolve, with hopes that economies will improve as vaccines are distributed. An improving economy could lift bond yields, but it may also spur inflation, something investors should watch.
Short term interest rates (less than 3 years) are highly correlated and sensitive to Fed and ECB actions. We don’t expect a whole lot of movement in that part of the yield curve.
The longer-term rates (above 5 year) will likely be influenced by growth and inflation expectations. As 2021 moves into the second half of the year, those longer-dated rates may rise as vaccine distribution improves, allowing the economy to reopen and gross domestic product growth accelerate.
Combined with monetary and fiscal stimulus, inflation expectations may increase, causing the yield curve to slope up as rates for longer-dated maturities rise.
Profit taking in longer-dated rates?
We do think it would be advisable to take partial profits on long bond positions as we had nearly 40 years of falling interest rates. Remember the nearly 16% on the 10-year Treasury at the end of 1981. Or the 11.50% on the 10-year German Bund also at the end of 1981.
The question is, where do we invest the cash if we want to stay out of more risky assets? Without any doubt, cash is one possibility for the coming months. Another possibility is to consider investing in investment-grade corporate bonds and emerging markets government bonds.
During 2020, investment-grade corporations issued a record amount of debt as they sought to raise cash during the pandemic, and now these companies have “a war chest liquidity”. Sectors to follow are energy and leisure, both massacred in 2020.
Emerging-market, US dollar-denominated sovereign bonds, which have yields of 4.7% and some Asian high-yield bonds with 7% yield are to be considered too.
But don’t forget: high quality bonds should make up the bulk of any bond portfolio!
Analyst Nucleus Group
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