Massive central bank action during the COVID-19 crisis has “rewritten the rules” of bond investing, according to one asset management giant.
Bond markets took a powerful hit in March as investors rushed to liquidate assets, but the monetary policy tools used to stabilise markets – including the RBA’s historic quantitative easing program and the Fed’s revival of its own – have reshaped bond investing dynamics, according to J.P. Morgan Asset Management.
“The Fed has done a tremendous job in returning the markets to some form of normality, injecting US$2 trillion of quantitative easing in just the past two months, compared to US$1.5 trillion over two years in the aftermath of the [global financial crisis] (GFC),” said Bob Michele, chief investment officer and head of global fixed income, currency and commodities group. “This has brought price stability and reduces volatility, but bond investors need to guard against complacency.”
With the Fed yet to outline its exit strategy – and indeed essentially guaranteeing markets that it will do “whatever it takes” – the massive scale of its quantitative easing program will distort pricing and mute traditional signals from bond markets on growth and inflation.
Governments will also likely have to keep interest rates well below nominal GDP growth to erode debt-to-income ratios – a concept known as “financial repression” – and fixing the cost of funding to keep debt affordable will be an “ongoing challenge” for monetary policymakers.
“Central banks have rightly stepped in to cushion the economic blow of COVID-19 and unquestionably succeeded in steadying the ship, but the long-term debt consequences are going to be substantial,” Mr Michele said.
Mr Michele suggests “co-investing” alongside central banks – following their lead by focusing on the investments they are buying, including Australian government bonds.
“The RBA’s own intervention has greatly reduced market dislocations,” said global market strategist Kerry Craig. “While the RBA is pushing back on taking the official cash rate negative, they are certainly not out of options to expand or make the bond purchase program more explicit if needed in the future.”
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