In 2018, the Federal Reserve reduced its glut of government debt by $350bn – the largest amount since the global financial crisis. 
Combined with rises in interest rates, slowing global growth, weaker corporate earnings and a trade war with China, (which sounds like 2020, excluding rates) every asset class suffered.
The S&P 500 was down 6.2 per cent in 2018. Investment grade corporate bonds dropped 6.4 per cent. And commodities plunged 15 per cent. It was one of the worst years for financial markets in decades.
After Federal Reserve chair Jerome Powell announced in December 2018 that the bond reduction programme was on “automatic pilot”, credit spreads widened as bond yields rose.
And there’s a risk of this being repeated if investors completely rule out the prospect of central bank intervention receding even modestly.
Look both ways
With corporate bond issuance on track to reach a historical high this year, investors appear to be confident that markets will be supported ad infinitum and will tolerate the increasingly paltry yields that are being suppressed by record-low rates.
This is indicative of the complacency displayed in 2018 when bond portfolios were hit by the Fed’s actions. Investors were only looking one way and weren’t considering the risk from continued Fed tightening.
Reliance on Treasuries within a portfolio could be dangerous right now, which is why our portfolios moved to their lowest levels in the securities in June.
Instead, 80 per cent of our portfolios are in high-quality quasi-sovereign or sovereign bonds, from issuers with strong balance sheets and robust credit ratings.
In the Middle East, the likes of Abu Dhabi Crude Oil Pipeline, an AA-rated bond, rose more than 23 per cent from the March lows to end-June and still remains attractive at around 3 per cent yield, 190 basis points off the spread over US Treasuries.
And while the Mexican oil company Pemex, which is state-owned, faces challenges like its peers due to low Brent crude prices, it is rated BBB by S&P.
The rationale here is that the rating agency does not believe the Mexican government would want the firm to fail given its status as a huge employer.
The bond’s large spread above US Treasuries feels too wide to us and should contract, pushing the price up.
Balancing quality and yield should allow investors to face what the Fed does next.
Freddie Coldham is head of fixed Income and currencies at Stratton Street Capital. The views expressed above are his own and should not be taken as investment advice.