Inflation will remain high this year but that doesn’t mean a bond crash is likely to follow, according to Jim Leaviss, head of public fixed income at M&G and manager of the Silver-rated M&G Global Macro bond fund. Speaking at the Morningstar Investment Conference 2021, Leaviss says the recent spike in inflation could be “defining moment for bond investors”, but there are a number of reasons why bond yields are likely to remain low for the forseeable future.
Inflation is one of global investors’ biggest concerns this year and many indicators are flashing red as economies re-open. Consumer price inflation rose 5% in the US last month, at the fastest rate since 2008. Everywhere consumers look, prices are rising, from fuel to houses and cars. Inflation is generally bad for bonds because because it erodes the real value of their income payments, and usually forces central banks to raise interest rates, meaning investors can get better yields elsewhere. That explains the spike in governement bond yields in recent months and fall in prices (the two move in opposite directions).
Leaviss says that in his multi-decade career as a bond investor predictions for a crash have come and gone, while official interest rates and bond yields have drifted ever lower over the years. Currently, a two-year UK gilt pays a measly 0.05%, although this is higher than last year. “Markets have got this wrong so many times,” he says. While he accepts that this time may be different, he thinks that investors should not “make a one-way bet” on global economies roaring back to life as people start spending again, triggering a bout of inflation and rate rises that could wipe out fixed-income investors. Investors need to be wary of interpreting data that compares 2021 with 2020 because most economies were in the deep freeze last year, he argues. He thinks US inflation may already have peaked and is already on a downturn. Beyond short-term spikes in monthly data, he says that these “megatrends” will keep bond yields low (and prices high):
Demographics
Ageing populations mean more retirees, who need safer, low volatility and income-paying assets like bonds. Bond buying supports prices and keeps yields low.
Employment
Tight labour markets and rising prices often mean workers can negotiate higher salaries, keeping inflation high. But not this time. There will still be plenty of people chasing jobs as government support schemes are withdrawn. The growth of “gig economy” jobs like Uber and Deliveroo drivers is an early example of this shift in the labour market. Leaviss expects there to be "long-term scarring" from the coronavirus crisis.
Technology
Internet shopping means that consumers worldwide are used to being able to source cheap goods, and this has kept a lid on price rises across the world.
Emerging Markets Offer Opportunities
Where does Leaviss see opportunities for bond investors this year? He has used the recent spike above 2.5% for US 10-year bonds to buy longer-dated government bonds, but has cut exposure to investment grade corporate bonds as prices have recovered. While he thinks the risk of default, which gives company debt a premium over government bonds, is still moderate, “you’re not getting paid enough” to take the risks that companies present. He is most enthusiastic about emerging market debt because of the attractive valuations, above-inflation yields and cheap currencies of countries like Colombia, South Africa and Turkey. While countries like Russia present political risk, inflation is less of an issue in developing countries than in the past. He also like emerging markets because demographics, unlike in the West and Japan, are on their side. These young, dynamic countries have less debt, a larger working population and smaller healthcare and pension liabilities than than in the developed world. For bond investors, it means the rich world’s economic growth is likely to lag emerging markets, meaning yields will remain low.
