It's time to rethink your bonds strategy

In last week’s article we concluded that we are not on the verge of another crisis, we are just at the beginning of a late economic cycle. The market came to the same conclusion last week as we saw equities rebounding on Friday as the S&P 500 posted its biggest weekly gain since 2013. The US 10-year Treasury yield also closed tighter as it retreated below 2.9% and the VIX closed below 20%, signalling investors were less nervous than a week before.

However, we are clearly not out of the woods. It is evident that the weakness in the market is due to rising interest rates, and it is also clear that interest rates are going to rise faster than expected. Investment banks are rushing to change last month's view that the US Treasury yield will close at 3% by the end of this year as they see that US Treasury yields are rising fast, and they were not afraid to break the 2.9% level last week as the US CPI numbers came out strong. The only problem now is: are they going to stop?

Now that the economy is growing, wages are rising, inflation is picking up and the Federal Reserve seems likely to accelerate interest rate hikes, investors have to accept that times have changed. The more good news that comes out of the US, the bigger the probability that US Treasury yields will rise, provoking imbalances between equity and fixed income markets and pushing stocks for further correction. After all, if you can get a higher yield by investing in safer assets such as bonds, why would you pay high numbers to be in the riskier equity market? That’s definitively a nonsense.

What is good to know is that by acknowledging we are living in a time of economic expansion, we can position ourselves to benefit from it. Industries that are going to benefit from this cycle are those we first saw suffering because of the financial crisis in 2008: this is any industry that is directly exposed to consumer spending. Consumer staples, retail, and real estate are among those that are going to benefit the most as now consumers have more money to spend. The strong stock market, a growing economy and rising wages means retailers will see more people in their shops who are ready to spend.

The energy sector will also benefit from solid demand due to the inflationary pressures that are building. The same can be said for commodities and utilities, as commodity prices are supported by high demand.

Locking in returns

What investors are scared of is that a late cycle may suddenly translate into a recession, whereby the sectors we mentioned will suffer and decline sharply. But can we really expect a recession in the next few months? Probably not. This is because the economy is still thriving but central banks are still aiding the economy and are only now starting to taper.

What is certain is that from now, we cannot expect the values of bonds to rise, as the first lesson in the bond market is that if interest rates rise, bond prices fall. This doesn’t imply that it is not convenient to put money to work in bonds – rather the contrary. This is probably the right moment to lock in some juicy returns in safer assets in order to ride out an eventually falling equity market and have money to invest at a later stage.

As a reminder, Saxo Bank doesn’t only offer cash bond products. If you are interested in more speculative instruments to cater for a sliding fixed income market, you can find CFDs that provide exposure to Italian, French and German government bonds, as well as futures contracts to gain exposure to Japanese, US, UK and German government bonds.