Rising inflation and a potentially deteriorating growth backdrop have created a complicated environment for bond investors, a fixed-income portfolio manager says.
“There’s clearly a perception in the market that central banks are behind the curve,” said Richard Lawrence, senior vice-president of global fixed income at Brandywine Global Investment Management in a March 23 interview.
Safe haven bond markets in the U.S., Europe, and Japan seem to be responding exclusively to headline inflation pressure rather than to geopolitical issues, such as the Russia-Ukraine conflict, he said.
Any deterioration in global growth is being ignored, making for a “complicated environment,” Lawrence said.
In terms of how that impacts bonds, Lawrence said it’s all about inflation in the near term and markets are ignoring a “mediocre” growth outlook. Several economists have downgraded growth forecasts since the start of the year, citing the combination of rising interest rates, war in Ukraine and commodities prices.
All of this has created value in the bond markets, said Lawrence. The bond market suffered record losses in the first quarter of this year: the Morningstar U.S. Core Bond Index was down 6%, its worst quarterly loss since its inception in 1999. Yields on the U.S. 10-year Treasury note climbed more than 75 basis points from 1.48% to 2.24% over the course of the quarter, and were above 2.7% to start this week.
Lawrence, who manages the Renaissance Global Bond Fund, said if there is enough of a deterioration in the growth outlook, he will think about extending duration in developed bond markets, as rising yields have made bonds cheap.
For now, Lawrence favours bonds with a shorter duration as they may offer some protection. He also said there could be opportunities in emerging markets.
In 2021, emerging markets raised rates earlier and fairly aggressively. A year later, Lawrence said some of those markets could reach the end of their hiking cycles, bringing inflation pressures under control, which he thinks will provide an attractive entry point to extend duration.
Lawrence likes bonds from Brazil, Chile and Colombia. He said Russia could have provided a fairly interesting opportunity as well, but the war means it’s no longer an attractive investment.
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