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Jump in bond yields

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Investment market update (for the quarter ended 31 Apr, 2021)

The most significant market move over the last quarter was the jump in longer-term interest rates.

Bond prices move in the opposite direction to interest rates (or bond yields) – when yields rise, bond prices fall (and vice versa). For years (or really decades) bondholders have benefited from falling interest rates, and therefore rising bond prices.

Over the last six months the direction has reversed, with higher long-term bond yields resulting in some of the biggest bond price declines for many years. Shorter-term rates didn’t rise as much, but most bond portfolios would have lost value over the past six months.

For investors who plan to own bonds to maturity, these “losses” on bonds aren’t permanent – holders will still receive the same interest on their investment and be repaid in full when the bond matures (unless, of course, the borrower defaults, generally not a common event).

Higher interest rates reflect the improved outlook

A powerful combination of huge stimulus measures from central banks and governments (literally injecting trillions of dollars into the global economy) coupled with Covid-19 vaccine rollouts has boosted economic activity around the world.

Not all that money has yet been spent. Savings have been boosted in many countries. Today’s higher-than-normal savings could support economic activity in the future.

The rise in bond yields reflects confidence in an ongoing recovery, but also the risk of higher inflation medium-term. Higher inflation lowers the value of money over time – investors, therefore, demand higher interest rates to compensate.

Inflation remains a key uncertainty for markets. We do expect inflation measures will jump in coming months as (1) prices recover from the falls seen during last year’s lockdowns, and (2) supply constraints and shortages of skilled workers (often due to current migration restrictions) around the world push up costs for businesses, which are being passed onto consumers.

The chief unknown, however, is whether this inflation will be temporary or sustained. Central banks’ current view is it will be transitory, but there is a risk it becomes more entrenched.

Equities continue to perform well

Despite the jump in longer-term interest rates, it has still paid to remain invested in equities. Global equity markets have continued to push higher with companies generally delivering better-than-expected results benefiting from a combination of improving economic activity and significant cost savings.

A softer New Zealand market the exception

New Zealand equities underperformed major markets over the quarter.

The NZX50 market index is dominated by a relatively small number of companies – the largest eight companies account for around half the index. What that means is any price changes (up or down) in these larger stocks has a significant impact on the overall index.

During the quarter we saw falls in some of New Zealand’s largest listed companies, for company or sector-specific reasons, plus a general pullback in defensive, dividend stocks – which dominate the market.

Clean energy exchange traded funds’ (ETFs) buy high, sell low strategy has caused significant volatility in electricity stocks, particularly Meridian Energy (New Zealand’s second largest listed company) and Contact Energy. For a deeper discussion please see our

Focus article ‘Sleepy Joe causes a power surge’ published on 15 February.
A2 Milk lowered revenue and earnings guidance for the third time this year. Border restrictions are limiting how much of A2’s product is getting to the key China market.

Cautiously optimistic

We remain confident in a strong global economy over (at least) the next 12 months or so. That said, there are still risks for markets.

Asset prices are not cheap by any historical reference, and levels of speculation and exuberance in markets are high.

Risks of higher-than-expected inflation and therefore upward pressure on interest rates is higher than it has been for a fair while. These factors mean we do expect future returns are likely to be lower than what we’ve seen over the past decade or so.

This column is general in nature and does not take any of your personal circumstances into account. For personalised financial advice, contact Forsyth Barr for an overview of the services we can provide.

Brett Bell-Booth
Investment Advisor with Forsyth Barr Limited in Tauranga. Phone: (07) 577 5725 or email brett.bell-booth@forsythbarr.co.nz

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