Capital IdeasTM
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Fixed Income
Flavio Carpenzano
- The extent of the sell-off in fixed income markets has been both large and rare relative to history, with returns across bond markets hitting historical lows.
- Yields have increased sharply alongside more hawkish central banks, creating an attractive entry point for investors.
- Volatility is expected to remain high, but income return could provide a buffer for volatile price movements going forward.
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.
US Treasuries 6-months rolling returns distribution since 1973
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Past results are not a guarantee of future results.
Return distribution of the Bloomberg US Treasury Index from 30 June 1973 to 30 June 2022.
Based on monthly data. Source: Bloomberg
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.
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Past results are not predictive of results in future periods. It is not possible to invest directly in an index, which is unmanaged. 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. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.
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