Given the relative failure of bonds to dampen volatility and move inversely with equities since the start of the pandemic, many allocators may have pondered the point of owning bonds at all.
That may have been particularly true in 2024, as equity markets rose stoutly, while in 2021, when equity markets fell, so did bonds.
But in a world where idiosyncratic risks abound, what role can fixed income as an asset class play in portfolio construction?
Myles Bradshaw, head of global aggregate strategies at JPMorgan Asset Management says the macroeconomic picture is unclear, meaning many of the normal assumptions around performance may not hold, but fixed income can still prove useful.
He says: “The cyclical outlook is cloudy, with downside risks to growth emerging alongside somewhat sticky inflation and a potential inflation shock from tariffs.
“However, the current level of interest rates suggests a more favourable environment for bond investing. Central banks raised interest rates into restrictive territory during 2022. Lower inflation and wages pressures in 2023 allowed central banks to adjust rates lower in 2024 but to levels that are still seen as generally restrictive for growth.
“This should reassure investors that any unexpected inflation shock today is unlikely to see a repeat of the 2022 hiking cycle. Instead, central banks are likely to keep rates unchanged at a somewhat restrictive level for a longer period of time.”
If we didn’t have to have bonds for ‘tradition’ would we still hold them now?
If interest rates are kept at what Bradshaw views as a “restrictive” level, that is, sufficiently high as to prove a drag on the growth rate within the economy, then the likelihood is that growth will be muted, making the fixed returns available from the income paid on a bond relatively more attractive.
He does, however, believe the volatility which has been a feature of the asset class in recent years will continue, as “economic uncertainty is increasing on the back of US tariff fears and the associated risk of tariff retaliation”.
He said: “If this economic uncertainty leads to a sharper growth slowdown, global central banks have plenty of room to cut rates in order to avoid recession. These rate cuts could potentially deliver double digit bond returns, enabling bonds to diversify the growth risks in investors’ multi-asset portfolios.”
Greg Venizelos, fixed-income strategist at St James Place is another who believes volatility will be an ongoing feature of bond markets, particularly of government bond markets, and particularly at the long end of curve.
That’s a curiosity as it is precisely those bonds which are owned in many multi-asset portfolio as a way to dampen volatility.
