The effect has been an anchoring of government bond yields and implicit support for riskier assets such as corporate and high yield bonds.
With interest rates close to all-time lows and artificially low government bond yields, returns from gilts have been positive, but muted.
However, the accommodative monetary policy has supported credit spreads, resulting in double-digit returns for investors in corporate bonds.
Performance of sectors in 2012
Source: FE Analytics
Long-term UK inflation continued its decades-long upward trend, with the rate persistently exceeding the top end of the mandated range.
Ordinarily, the combination of elevated inflation and low nominal bond yields is a destructive mix for bond holders, as inflation wipes out nominal returns.
Indeed, real rates available for investors in short-dated bonds have been negative in the UK and other developed markets.
Naturally, investors have looked at ways to improve prospective returns. This is behind the move to higher-risk assets such as higher-yielding bonds or longer maturities.
Another well-trodden path is towards absolute return bond strategies; here, a broader opportunity set can improve prospective returns and reduce the risk of capital loss inherent in rising bond yields.
Across the globe, the themes are the same – excessive indebtedness resulting in necessary deleveraging, at government, corporate and household level. The process is proving painful, and is suppressing economic activity.
Europe’s governments and institutions have struggled to navigate a path through the eurozone sovereign debt crisis.
The year was characterised by numerous changes of government and frequent displays of brinkmanship. Typically, policymakers only found a way forward at the eleventh hour when default or market crisis loomed.
The European Central Bank’s [ECB’s] actions have given markets a measure of comfort and bought politicians some breathing space. Spreads on peripheral European government bonds have contracted markedly, even though there is still no clarity as to the shape of a fully resolved Europe.
The manipulation of government bond yields as a policy instrument has blunted the linkages between the real economy and market yields.
As long as austerity measures and deleveraging continue to limit economic growth, the timing of any upward move in yields is uncertain, but it is unlikely to happen soon.
Central banks state that policy rates will remain at super-accommodative levels through 2013 and well into 2014.
By normal standards, this has been an extended recession – but not by the standard of debt-driven recessions, which can and do last longer.
While bond markets act as forward-looking agents, anticipating any change in future policy ahead of the event, they will require clear evidence that any economic recovery is well established.
For their part, policy makers are acutely aware of the risks of choking off a recovery by the early removal of stimulus.
We believe interest rates will stay low and risk assets will remain supported. Inflationary pressures will continue to build, but will only begin to concern policymakers when a recovery is more entrenched.
Mark Connolly is the director of fixed income at SWIP. The views expressed here are his own.