Bond markets ended 2021 in a state of turmoil, with investors accepting the prospect of higher inflation and more “normal” monetary policy. Many investors are now wondering what implications this momentous transformation could have on bond markets over the next year and beyond. “While it may seem a daunting prospect, market difficulties can also create new opportunities, as long as bond investors stay focused and patient,” said Sarang Kulkarni, Lead Portfolio Manager for Vanguard Global Credit Bond Fund.
Right now, while vaccination campaigns are driving the economic recovery from the pandemic, there is less justification for continuing with stimulus policies. As a result, major central banks have begun to curtail their bond purchase programs and have indicated that rate hikes are imminent. “As for the bond markets, this has caused yield curves to start to flatten as short-term rates have risen more than longer-dated ones, and phasing out quantitative easing is likely to put further pressure. to the upside on bond yields at the short end of the curve, “Kulkarni predicted.
Bond markets are faced with the prospect of a prolonged period of slowdown in growth and a rise in short-term rates. This is the part of the credit cycle where risks begin to increase. “Rising rates may make cash appear more attractive than other asset classes, while slowing growth may push corporate executives to increase debt through acquisitions, higher-than-normal dividend payments and buybacks. In such a situation, credit opportunities will be more idiosyncratic than ample, “the expert noted.
While the monetary policy path is under control, the key driver for global credit markets will be how economies hold up when central bank support measures fail. Furthermore, if the pace of rate hikes is too fast – if central banks make a political mistake – the slowdown in growth could be faster than expected. “In such a situation, the bond sector enters a rather vulnerable position in 2022 and we expect a further increase in volatility over the course of the year,” Kulkarni predicted.
Not only. Rising rates could weigh on the total return on high-quality credit. “In recent years, a number of credit sectors, such as US tech firms, have benefited from favorable liquidity and relatively easy access to finance. And as monetary policy tightens, equity markets may come under pressure with slowing earnings growth, rising financing costs and normalizing equity multiples. Some high-quality firms have begun to take advantage of what could be the end of easy monetary conditions by launching large funded acquisitions in cash, which could put pressure on their credit ratings.
This will also likely lead to greater dislocation in some of the low-rated segments of the credit market; in other words, there is likely to be a clearer demarcation between credits with – and those without – adequate liquidity to ride out any major macroeconomic shocks and interest rate volatility, he pointed out. As volatility and dislocation increase, the underlying risk-return dynamics of active bond portfolios are more likely to be exposed. Focusing on the direction of the bond markets in an attempt to produce returns, the so-called “levered beta”, which can sometimes pay off in risk appetite scenarios, “can be penalizing in volatile situations.
Therefore, the best way to navigate the bond markets in their current form is to adopt a disciplined approach, that is, thanks to adequate diversification, the patience to wait for interesting opportunities and a careful choice of securities. “We believe that the global bond universe offers a wealth of opportunities to produce alpha for investors. In our view,” concluded Kulkarni, “now more than ever is the time to derive alpha from a genuine choice of securities by diversifying sources. , without taking excessive top-down directional risk “. (All rights reserved)

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