Your browser does not support JavaScript! Pls enable JavaScript and try again.

Fixed Income

Rising Rates and Implications for Fixed Income Portfolios

Posted on
  • Unlike 2020, broad fixed income returns have been negative in 2021 with the global bond aggregate off -1.4% year-to-date. This has been led by US Treasuries across the curve at -2.1% in total return (as of 22 Feb 2021). Citi analysts expect further yield curve steepening and the 10-year US Treasury rates to rise into the 1.50-2.0% range as further stimulus is injected into the economy over the course of 2021, having touched 1.55% on 25 Feb 2021. Further fiscal stimulus combined with an accommodative Federal Reserve policy is likely boost the US economy as it reopens post COVD-19. With this massive expected infusion of stimulus (more than 10% of GDP in 2020 and 2021) comes the risk of higher inflation.

 

 

  • Rising rates have important implications for fixed income portfolios. First, longer-dated fixed income instruments are likely to track Treasury prices moving lower and could incur a mark-to-market hit. With the recent re-pricing, corporate bonds yields are becoming more attractive on a nominal and real basis. Investment grade bond yields are now on average closer to inflation break-evens. High Yield (HY) bonds offer positive yields and many are geared to positive economic news. However, given their leverage, rising rates may negatively impact the credit risk of some issuers thus variable-rate bank loans are preferred which are higher on the capital structure. The additional protection to rising rates embedded in variable-rate bank loans also makes them attractive alternatives for adding risk.

 

  • Other fixed income instruments that may provide some mitigation to rising yields and widening spreads include: Treasury Inflation Protected Securities (TIPS), which pay higher yields as inflation increases; Emerging Market dollar bonds, which offer near HY-yields in companies with lower leverage and whose earnings could benefit from higher commodity prices; Financial institutions preferred bonds, which also offer near-HY yields in companies whose earnings are likely to benefit from a steeper yield curve. Despite the recent rise in Treasury yields and a possible move higher, Citi analysts think investors could benefit by holding a diversified set of fixed income alternatives within portfolios.

Related Articles