Investors should snub the market’s summer ease back from recent volatility and expect a rougher ride in fixed income markets from September, according to Janus Capital’s Bill Gross, who says central bank policies since the financial crisis have worsened the asset market’s woes rather than solving them.
Markets have been on tenterhooks following the latest statement from the Federal Reserve yesterday after the US central bank did not rule out an interest rate rise in September as many had expected.
The bond market guru says a September interest rate rise by the Federal Reserve is now very likely and that worries over Greece and the broader eurozone market could re-surface around the same time, spelling panic for fixed income investors.
“There is no statistical reason per se for the Fed to raise interest rates, yet absent a major global catastrophe we are likely to get one in September. But the reason will not be the risk of rising inflation, nor the continued downward push of unemployment to 5 per cent,” he said.
“The reason will be that the central bankers that are charged with leading the global financial markets – the Fed and the Bank of England for now – are wising up; the Taylor rule and any other standard signal of monetary policy must now be discarded into the trash bin of history. Low interest rates are not the cure – they are part of the problem.”
The Taylor rule refers to how much a central bank should adjust interest rates as inflation or other economic data changes in order to try and control the economy and/or inflation.
Gross says while low interest rates were meant to stimulate corporate investment, this has been “anaemic” while other structural reasons for bad reactions to higher interest rates abound.
“There are other negatives which seem to be directly the result of zero bound interest rates. Three-month Libor rates have rested near 30 basis points for six years now and high yield spreads have narrowed and narrowed again in the quest for higher investment returns.”
“Because BB, B and in some cases CCC-rated companies have been able to borrow at less than 5 per cent, a host of zombie and future zombie corporations now roam the real economy. Schumpeter’s ‘creative destruction’ – the supposed heart of capitalistic progress – has been neutered.”
“The old remains in place, and new investment is stifled. And too, because of low interest rates, high quality investment grade corporations have borrowed hundreds of billions of dollars, but instead of deploying the funds into the real economy, they have used the proceeds for stock buybacks. Corporate authorisations to buy back their own stock are running at an annual rate of $1trn so far in 2015, 18 per cent above 2007’s record total of $863bn.”
Fixed income funds have been through a tough time so far in 2015, with more than 70 per cent of the 146 portfolios in the IA Global Bonds sector losing money this year.
Those in positive territory have only managed returns under 5 per cent and include the $748m Janus High Yield fund, which has returned 3.48 per cent this year.
Performance of sector in 2015
Source: FE Analytics
Most fixed income funds in general have seen a rocky six months or so since volatility in government bonds, particularly in Europe, ramped up and markets sold off on the back worries that the eurozone was heading for a ‘Grexit’.
Gross says this worry, while dormant for now, could be set to resurface in the near term, adding further woe for markets.
“The Greek/German tragedy of midsummer seems to have landed on terra firma for at least a few months, although inevitably the weakness of the eurozone with its common currency, but disparate fiscal philosophies spells renewed turbulence in financial asset markets.”
“The eurozone – and the European Union itself as Britain’s 2017 referendum may eventually reveal – is a dysfunctional family and may always be. They are all so different that a common purpose seems to be missing.”
“[Mario] Draghi’s European Central Bank and the Merkel-controlled eurozone ascribe to the old theory of ‘feed a fever, starve a cold’ – the ‘fever’ in this case being financial bull markets fed with 0 per cent credit, and the ‘cold’ being fiscal austerity starved by balanced budgets. So far, the philosophy seems to be working well for Germany, miserably for Greece, and not so well for all other eurozone countries in between.”
Nick Hayes, manager of the £240m AXA Sterling Strategic Bond fund, says he is also worried the next few months could be severe for fixed income and is therefore maintaining a defensive stance in what he thinks will be increasingly volatile market environment.
“Our quarterly fixed income forecasting asserted the need to maintain a cautious approach in the short-term since volatility in fixed income is likely to continue at a higher level over the coming weeks and months,” he said.
“We see two main risks for the foreseeable future, which would cause volatility to remain high in fixed income markets. In the short term, concerns have moved from the Greek crises to the commodity sell off that has been underway.”
“What could be more critical to bond markets over the coming months is the general re-pricing of fixed income assets from a more aggressive stance by the Fed.”