Should investors hold onto bonds?
Bond yields sank to very low levels earlier this year. The bottom turned out to be too low, in fact, and markets whipsawed when the strain became too much. Since April 17th yields have retraced significantly. The concomitant drop in futures prices has reached 7.75% for 10-year German Bunds and 3.9% for same-dated US Treasuries. That might seem like a rout, but actually recent history has been rife with similar movements.
The problem is that such pullbacks increase the risk inherent in investment portfolios and raise two interlocking questions. Will the correction in bond markets continue? And, if so, should investors go on holding debt instruments as a hedge against other dangers? (...)
Is the impending rise in us interest rates to be feared?
The statement issued after last week’s FOMC meeting on US monetary policy leaves little room for doubt that the Federal Reserve System (Fed) is preparing to raise its benchmark interest rate in the second half of this year, probably in October. Although the communiqué had little impact on the emerging markets, there are lingering questions about the repercussions of the coming rate hike and the attendant increase in US bond yields. Actually, emerging stockmarkets tend to react in inverse proportion to the trend in US Treasury yields, since an upturn in the latter drives up refinancing costs and thus dents the performance of equities.
When the US central bank announced in May 2013 that it would gradually reduce its programme of quantitative easing, the ensuing “taper tantrum” caused emerging economies that are burdened by chronic current-account deficits to lose momentum. That is because such countries’ governments need to borrow in international bond markets (and thus often in US dollars) to cover domestic over-consumption. As a logical consequence, the rise in US Treasury yields hit these net-borrower countries hardest. (...)