Originally published by BetaShares
Assuming an easing in current global trade war concerns, it still seems likely that global long-term bond yields will rise rather than fall somewhat over the next year or so. This note examines the likely impact on fixed-income bond returns, and the degree to which the prospect of higher rates can already be “priced” into the market.
As seen in the chart below, long-term bond yields in Australia have lifted somewhat from the low of mid-2016 – largely due to higher rates in major industrial economies such as the United States, as central banks have started to gradually withdraw policy stimulus. That said, bond yields still remain somewhat lower than the average prior to the global financial crisis, and further gains seem likely especially if the Reserve Bank eventually moves to lift local short-term interest rates also.
At face-value, rising bond yields are not great news for holders of fixed-rate bonds. After all, higher market interest rates tend to reduce the market value of fixed rate bonds, because their future stream of fixed nominal interest payments are worth less in today’s dollars. The key measure of this price sensitivity to interest rates is known as the modified duration, which in turn is related to the remaining term-to-maturity of the bonds in question.
For example, one of the most commonly used bond benchmarks for local fund managers and Australian Bond ETFs is the Bloomberg AusBond Composite Index (BACI). The BACI is weighted by bonds on issue in the Australian market and as such has around a 90% weight to Government bonds and 10% weight to corporate bonds and an overall modified duration of 5.2 years as at end-May 2018. This implies that a 1 percentage point increase in the general level of market interest rates that applied to bonds in this Index would overall lower the market value of bonds in the Index by 5.2%.
So far so bad – but there are three countervailing points worth considering.
As seen in the chart below, for example, the BACI has experienced periods – typically when bond yields are rising – in which returns under perform that available from cash, as proxied by 1-month bank term deposits*. But these periods of under performance have tended to be brief, and have been soon recouped from the higher income returns that long-duration bonds tend to offer over term deposits.
Source: Bloomberg. Past performance is not an indicator of future performance. You cannot invest directly in an Index.
All up, while bond price returns will tend to be reduced as and when bond yield rise, overall returns will be supported to some extent by the generally higher income they offer – especially compared to more capital stable assets such as cash. From a longer-term perspective, moreover, higher bond yields are good news for investors in long-dated fixed-rate bonds as income returns will tend to increase over time.
*Monthly term deposits rates sourced from the Reserve Bank of Australia, which is based on the average rate offered by Australia’s 5 largest banks.
Add a Comment
Are you sure you want to block %USER_NAME%?
By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.
%USER_NAME% was successfully added to your Block List
Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.