As rates rise globally, bond investors must be vigilant, but also—like central banks themselves—measured.
In weekly market commentary, Richardson GMP posits that inflation pressures are building but will continue to do so for some time, “perhaps for the duration of this cycle.” That’s because, for example, technological efficiency and global trade act as inflation suppressors.
When inflationary pressures eventually translate to sustainably higher bond yields, “the equity market will face a big headwind and likely decline,” says the report. “These will be buying opportunities in the near term as the market cycle continues to have enough momentum, with limited risk of a near term end-of-cycle.”
Fixed income focus
Similarly, Geoff Castle, portfolio manager at Pender, says in monthly commentary that the potential for central banks to quickly normalize rates is limited. His view focuses on the potential consequences of rate hikes.
“Overhanging the market is a large amount of consumer and corporate debt that was assumed in the past decade at very low rates,” says Castle, who manages a corporate bond fund. “As rates rise, borrowers must refinance at higher cost,” which could result in “cracks in various sectors of the debt markets.”
Those cracks could appear in housing, he says, where property owners are potentially overextended on mortgages for overvalued properties. Another potential crack is “the high-yield debt of companies that were either over-levered or where the issuer is domiciled in an industry subject to disruption,” he says.
If credit stress emerges, the increases in government yields at middle tenors (three to seven years) may stall.
“If that were to happen, it would be quite good news for high-quality corporate bonds of these durations,” says Castle. “So we have been building a position in this kind of holding, not knowing when these positions will stop declining in price, but confident in an eventual turnaround.”
As an example, he cites maple bonds such as McDonalds, Pepsi and Walt Disney, issued in Canadian dollars. Further, “We added a 2025 bond from consumer products giant Mondelez this month,” he says.
Though his fund has a buildup in investment grade bonds, he also focuses on well-collateralized, short-duration high-yield bonds. Such bonds perform well during rising rates because “spreads are wide enough that small moves in the government curve matter much less to the credit than the market’s view on the value of the issuer’s assets,” says Castle. An example from his portfolio is Amyris 2019 notes.
For more details, including additional specific holdings, read the full Pender commentary.
For more on inflationary pressures and associated historical data, read the full Richardson GMP report.