Irish investors have been warned that they could stand to lose money as the global bond sell-off gains pace. However, despite falling bond prices, investors are being advised to sell down, but not out of, their bond holdings.
As the outlook for the global economy continues to improve, the bond market has started pricing in higher future central bank interest rates, which has pushed longer dated bond yields higher.
"While fiscal stimulus in the US has been an aggravating factor, we believe the rise in yields has been mainly driven by an improving outlook for the global economy," said Oliver Sinnott, fixed-income fund manager with Davy Asset Management.
This has led to a “significant” bond sell-off. Yields on 10-year US treasuries for example rose by 0.6 per cent, from 2.3 per cent to 2.9 per cent in just over 10 weeks, for example, and as yields rise, the price of bonds fall – global government bond prices are down about 2 per cent since mid-December and early February.
Inflation pressures
And yields may have further to rise, which could see bond prices drop lower.
“We do not believe that yields have peaked,” Mr Sinnott said, adding that there is a “strong probability” that there is longer left in the cycle, which would leave more time for inflation pressures to build and central banks to raise rates more than the market is currently pricing.
Earlier this month, former Federal Reserve chairman Alan Greenspan warned that both the stock and bond markets are in "bubbles", spiking fears that bond prices could have some way to fall.
Sinnott, however, argued that a bear market for bonds is considerably different to that for equities, and thus losses for investors would likely be considerably less.
“High-quality government bonds are a less volatile asset class than equities,” he said, adding that the biggest peak-to-trough fall in global developed market government bonds over the past 25 years has been just 5.8 per cent, compared with 50 per cent for equities.
So, while investors might be expected to take the rational step and sell down their bond holdings if the outlook is for continued widening in yields and subsequent fall in bond prices, Mr Sinnott argued that there is still justification to hold bonds.
“The simple answer is diversification. We still believe that high-quality government bonds have a place in portfolios. They reduce day-to-day volatility and, more importantly, when the cycle ends and risk assets sell off, we expect bonds to rise in value and help preserve the value of portfolios,” he said, adding that in terms of an overall portfolio, investors should look to an “underweight position in bonds rather than holding no bonds at all”.
