Fixed income markets are pricing in a 3.5% base rate from the Bank of England, predicting there is a long runway of rate hikes to come.
At Morningstar's 2022 Investment Conference, head of fixed income at Royal London Asset Management Jonathan Platt told delegates that in an environment where bonds have been broadly returning in-line with equities, managers were now contemplating the role of fixed income in portfolios.
According to Platt, markets are pricing in a 25bps hike to the UK base rate by August, and predicts it will have risen to 3.5% in a year from now, equivalent to nine base rate increases of 25bps, with the situation being markedly similar with the Fed funds rate in the US.
"Fixed income markets are saying we are nowhere near finished in terms of interest rate hikes we are going to see. Growth forecasts at the start of the year were optimistic with 5% or 6% rates of growth globally, with the US doing particularly well on the basis that pent up savings would come back into economies."
"That has not proven to be the case."
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Platt explained that recent interest rate profiles are indicative of the direction of consumer price inflation, which he said as a fixed income investor, was a "chief issue" as was the direction of growth. He predicts interest rates at these levels will slow economies "pretty significantly."
Bond markets have rallied in the last two weeks, as investors have bet on a global recession, against the backdrop of rapidly rising interest rates and stalling growth.
Yields on 10-year US Treasury notes fell nearly 3bps in the three days to 1 July, the greatest movement since 2020.
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"The only way the Fed will actually bring inflation back down to levels they want is with a US recession. I do not think rates will go as high as that level implies because the slowdown of the economy sufficient enough to curb inflation will be lower than that."
"Yields are low by historic standards but this slowdown is on its way and it may not be pretty. Diversification is absolutely critical. Make sure you spread widely on an asset allocation basis and that you diversify in your credit strategy. Security and getting close to the assets of the issuer is important in the present environment."
Head of multi-asset at Rathbones and manager of the Rathbone Multi-Asset Strategic Growth Portfolio David Coombs told Investment Week that markets will turn fast when the Fed pauses on rate increases, which he believes will be sooner than many are suggesting.
"As part of the recession camp, we have been buying into this falling bond market in credit and government bonds over the last two months. That has been picking up, as conventional sovereign bonds are a good recessionary hedge," he said.
"I know it looks odd at the moment because of where inflation is, but we think inflation is coming down. We have been very active in the fixed income part of the portfolio over the last six months, buying into rising yields, and have taken profits through positioning for inflation and index-linked instruments."
