Dispelling Popular Beliefs Summary
For fixed income investors, the current macroeconomic environment presents uncomfortable choices, with policymakers walking a thin line between combatting inflation and averting (or at least mitigating) the recessions that often follow rate rises.
Market participants face a slew of competing concerns:
- Rising rates will hurt the asset class, or so runs the received wisdom, but substantial allocations are beneficial during recessions.
- Rising rates favour lower-quality credits, with their larger coupons providing a modest cushion against price declines and their generally shorter maturities reducing interest rate sensitivity,
- But recessions supposedly favour higher-quality (and generally longer maturity) credits as defaults surge.
- Market timing may be important, but asset owners such as pension funds are often reminded that they should not try to time the market.
Catch-22 scenarios abound.
To help determine the best course of action, bfinance look at three popular beliefs:
- Fixed income does poorly in periods of rising interest rates.
- Investment grade bonds outperform high yield bonds during recessions.
- Short-duration assets are less volatile than long-duration assets.
Historical data is not always a good predictor of outcomes. Each recessionary period and inflationary period since the 1970s has been different, with its own unique drivers and context. In addition, the role and prerogatives of those setting macroeconomic policy have evolved significantly over time: the Fed’s focus, for example, has shifted from maintaining low unemployment and growth (1970s) to addressing inflation (late 1980s) and, more recently, acting as the guarantor of the financial system (2008’s ‘GFC’ and onwards).
However, analysis does reveal some useful takeaways which may help to inform investors’ thinking as we consider the ongoing fixed income conundrum.
This is part of a series of articles from London-headquartered specialist consultant bfinance, based on their whitepaper: Recessions, Rising Rates and Received Wisdom in Fixed Income Investing.
