The yield on the US 10-year Treasury in early October this year reached its highest level since 2007. This surge in bond yields had a domino effect on financial markets, causing equities to decline and credit spreads to widen. Janus Henderson Investors believes that this rise in bond yields has brought the uncomfortable possibility of a third consecutive year of negative returns on longer-dated US Treasuries, an unprecedented situation.
According to the asset manager, the key element in this scenario is the concept of “real” yields. Core inflation peaked in the US a year ago, and headline consumer price inflation has since decreased. Meanwhile, real bond yields have risen, informs Jim Cielinsk, Global Head of Fixed Income at Janus Henderson.
“We can think of real yields as the annualised return a fixed-income investor can expect to earn after inflation. They are important as they often provide an insight into expectations of future economic growth and monetary policy,” he adds.
Subsequently, the asset manager lists various factors that have contributed to the rise in real yields. This includes increased bond supply, central bank policies, doubts about rate reduction and economic uncertainty. Rising yields have made bonds more attractive for investors, opines Cielinski. He suggests that bonds compare favourably to equities, offering better yields for investors.
Additionally, Janus Henderson contends that shorter-dated bonds are attractive due to their potential for positive returns with limited volatility. Longer-dated bonds could offer an opportunity for income and capital gains if bond yields decline, it adds.
“The reset in yields has created some compelling opportunities in fixed income, and with real yields at historically restrictive levels that are likely to slow the economy, we believe risk/reward is skewing in favour of bonds and away from risk assets,” says Cielinski.
In conclusion, the asset manager says that the present situation signifies a regime change for policymakers, and bonds are poised to resume their conventional role as a compelling option for portfolio diversification.
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