A decade after the financial crisis, investors have grown accustomed to low yields on bonds. But this situation is changing, especially in the US, where bond yields are on the return.
In a rising interest rate environment, bond yields tend to move higher. And after four rate hikes by the Federal Reserve in 2018, yields on certain benchmark government bonds have reached 2.5% for the first time in years – both in the U.S. and among a few issuers in Europe.
Will the Fed continue to tighten?
The Fed has lowered expectations of further interest-rate rises this year, but we believe the strength of the U.S. economy means future hikes are still possible, for several reasons: First, the US economy remains strong, and while we forecast that growth will ease to 2.4% this year, we are not forecasting a US recession over the next 12 months.
There are several factors that suggest the US will see further solid growth:
- A strong labor market
- Higher wages
- Solid business and consumer confidence; and
- Manufacturing output, which is holding up.
Against this backdrop, we believe US government bonds that are due to mature sooner – in particular, 2-Year Treasuries – offer an attractive risk-return profile for investors.
Why 2-Year Treasuries look more attractive
Because the US yield curve has flattened in recent months, bonds due to mature sooner have roughly the same yields as those due to mature over the longer term. Historically, this has been a sign that the market is growing concerned about the possibility of recession and is therefore disincentivising long-term borrowing
For investors, it means that by investing at the ‘short end of the curve’ you could pay a lower opportunity cost than usual, while being less vulnerable to further interest rate hikes.
Outside the US, the outlook for fixed-income investments is mixed. But if investors move with caution and choose selectively, we believe there are still opportunities to be found.
Source: DBWM CIO Insights Annual Outlook 2019. As at January 7 2019. No assurance can be given that any forecast or target will be achieved. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis, which may prove to be incorrect.