The falls seen in bond prices means bond yields on UK corporate bonds have now risen to 7 per cent, roughly matching what the markets are forecasting for inflation in the next 12 months.
Market pricing in too much
However, Snowden says the attraction for this 7 per cent yield comes in the longer term, with inflation forecasted to fall to less than 4 per cent in 12 months and 3 per cent in the following 12 months after that.
Stuart Steven, co-manager of the Liontrust Sustainable Future Monthly Income Bond fund, concurs that the market has priced in too many interest rate hikes, given rates are ineffective at reducing supply-side inflation.
He says: “Retail sale volumes are already contracting and the slow pass-through of rate hikes (due to fixed rates and term funding) will likely result in a greater economic slowdown if the BoE hikes as much as the market expects.”
There is evidence of this opportunity growing in other parts of the world too.
Janus Henderson portfolio managers Daniel Siluk and Jason England say the repricing of markets has increased the asset class’s capability of fulfilling its core tenets of generating income and providing diversification to riskier assets – characteristics that have been lacking since the global financial crisis.
Although yields are at improved levels, they say the maturities are not distributed in a normal manner – citing the inverted US and Canadian yield curves as an example.
The pair add: “We believe that the combination of flat-to-negative yield curves, along with elevated economic uncertainty, supports an overweight higher-quality, shorter-dated securities at the expense of the longer-dated bonds that we believe remain vulnerable to additional bouts of volatility.”
The pair say the worst-case scenario would be a wage/price spiral taking hold or supply chains remaining impaired, meaning inflation and bond prices would start rising again.
In a nutshell, if rates do rise one or two more times – most of which is already priced in by markets – and you buy, for example, a 30-year long duration bond, should interest rates fall by 1 per cent you will make a lot of money. But the level of uncertainty does remain rife, so if rates rose by 1 per cent, you then open yourself up to a significant capital loss.
By contrast, a short-duration bond makes far more sense as you are getting up to a 7 per cent yield on some bonds over a period that is less sensitive to interest rate risk.
