What Are Bond Investors Thinking? Their Three Top Concerns
Bond investors are worried, and who can blame them? From rising consumer prices to taper tantrums to climate change, there’s a pressing concern around every corner. Below, we share our risk assessments, as well as some risk-mitigation strategies. Plus, one bonus worry: bond manager technology (if you’re not worrying about this, you should be).
Worry #1: Inflation
The US is the center of concern around rising inflation, thanks to massive fiscal stimulus supporting a rapid recovery. US inflation continued to soar in May, with the Core Consumer Price Index (CPI) up 0.7% month over month and 3.8% year over year—its highest annual rate in more than 25 years.
We believe this jump in inflation is transitory. We expect price increases to decelerate as the year progresses and as pandemic-induced supply constraints ease, allowing supply to catch up to demand and taking the pressure off prices.
Could inflation become a worry in the euro area? Not anytime soon. The European Central Bank recently put its 2023 inflation forecast at just 1.7%, highlighting how far it is from achieving its inflation goals (and indicating that ongoing asset purchases will be needed long after the Pandemic Emergency Purchase Programme has expired).
While we don’t think inflation will become the major concern it was 50 years ago, investors are wise to make some adjustments to their portfolios. Even moderately higher inflation erodes the real value of investment returns and often leads to higher interest rates. In today’s inflationary climate, investors might consider these strategies:
- Modestly reduce the portfolio’s duration, or sensitivity to interest rates. Prices on shorter-term bonds fall less than those on longer-term bonds as market yields rise. Shorter bonds can also be reinvested sooner in higher yields.
- Tilt the allocation toward credit to capture incremental yields and income. That includes increasing exposure to high-yield corporates.
- Diversify across higher-yielding sectors, such as US credit risk–transfer securities (CRTs), with low correlations to government bonds and to each other. CRTs are floating-rate bonds backed by real assets—homes—that often benefit from inflation. Thanks to a robust US housing market, fundamentals look attractive for CRTs. Select emerging markets also look attractive and provide a diverse source of potential return.