Capital Ideas^TM

It’s been a turbulent start to the year for fixed income markets

As shown in the following graph, fixed income markets have experienced one of the most, if not the most, turbulent period in history. To put it in perspective, US Treasuries returned -9.1% during the first six months of 2022¹, which is the worse six months rolling return since 1973. Such a negative return in a period where risky asset classes also sold-off significantly has put into question the role of

bonds as a diversifier from equities. Bond markets were affected by a sharp and rapid increase in interest rates triggered by more hawkish central banks whose priority suddenly shifted towards fighting worrisome high inflation.

However, the severity of losses in terms of total returns for bonds in a rising interest rate environment depends on three main factors: 1) the magnitude of the increase; 2) the speed of the increase and; 3) the starting level of yields. The slower the pace of interest rate increases, the more income fixed income assets can accrue to offset the loss arising from rising interest rates. For example, during the 2015 to 2018 interest rate-hiking cycle, it took a year before the US Federal Reserve (Fed) undertook its second hike and a total of 36 months for interest rates to be hiked by 225 basis points (bps).

In contrast, the first half of 2022 was the perfect storm for fixed income markets where all three factors mentioned above came together and acted as a headwind. In fact, since the beginning of the year the yield on 2 year US Treasuries – used as proxy for expected future Fed hikes – has increased significantly (around 220bps), rapidly (in only six months) and from a very low starting yield (only 0.73%) which did not provide any cushion for such an extreme and fast market move².This is the main reason for the significant mark-to-market losses bonds experienced so far this year.

1. As at 30 June 2022 as measured by the Bloomberg US Treasury Index. Source: Bloomberg

2. As at 30 June 2022. Starting yield of the generic US 2yrs Treasury (USGG2YR) at 0.73% as at 31 December 2021. Source: Bloomberg

 

Risk factors you should consider before investing:

• This material is not intended to provide investment advice or be considered a personal recommendation.
• The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
• Past results are not a guide to future results.
• If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
• Depending on the strategy, risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.