It's time to rethink your bonds strategy
Senior Fixed Income Strategist
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.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.