Bond market riot: Rates are rising but is it sustainable?

LONDON (Capital Markets in Africa) – The new year has awoken the bond market from its slumber. What began as a gradual climb in nominal yields from the summer accelerated in February with the yield on the US 10-year Treasury note briefly topping 1.6%, and significant moves higher globally including in Australia and the UK. Moves of this speed are rare, so Janus Henderson dedicated an ISG meeting to ask why global yield curves have steepened so quickly, when does a “good” rise in yields turn into a “bad” one, and what the implications are for fixed income asset allocation.

Taking a step back, the reflation trade has reversed some of the over-valuation in high-quality bond sectors. US 10-year yields have risen by more than 100 basis points (bps) from the lows reached in 2020, but when looking at the absolute level of yields, as shown in Figure 1, a few things are clear: First, the move is retracing an even faster decline in yields from just about a year ago when markets (rightly) feared a global economic collapse induced by the exogenous shock of COVID-19. Second, while the initial move upward was led by higher breakeven inflation reaching 2.25%, in recent weeks this has stalled and been followed by higher real yields,
which have moved off the lows.

Despite the sharp rise in yields and the corresponding rise in interest rate volatility, credit markets were not spooked. Corporate credit indices, by and large, saw spreads tighten in February, though they began to move wider in March. This is notable for credit markets as they tend to be more sensitive to spikes in volatility. They also tend to correlate more highly with equity markets, and global equity markets were on the surface unnerved by this (with the S&P 500® Index still close to all-time highs). However, this does mask the severe rotation within equities, with cyclical and value equities rallying and growth and more defensives underperforming sharply.

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The Janus Henderson Investment Strategy Group (ISG) brings together investment professionals from across the global fixed income platform and other Janus Henderson teams, providing a forum for research and debate on the key areas of fixed income asset allocation and macro-economic outlook, including rates and currency. It is designed to bring together our best ideas globally, aiding portfolio manager decision-making around both portfolio positioning and risk allocation. The ISG Insight seeks to provide a summary of recent debate within the group.