The Federal Reserve is preparing to raise interest rates, just as other regions like Europe are pushing ahead with easy money policies.
That has the potential to create a divergence in bond market performance, as the benefits of the low-interest rate environment that have helped US bond investors move elsewhere.
“If you think about the US experience, fixed income has done pretty well — everyone’s been worried about rate rises in the US for some time and fixed income’s actually done pretty well,” Raman Srivastava, Standish Mellon Asset Management’s codeputy chief investment officer and managing director of global fixed income, told Business Insider.
‘”Well why is that? Part of it’s an economic story — low growth, low inflation — but part of it’s because the central bank has kept rates low and they have actually been buying bonds.”
Many of the same factors are at play in Europe, Srivastava said. Inflation is low, growth is low, the central bank is buying bonds, and the region is also ageing demographically. It could be an attractive option for bond investors.
There is one problem: the foreign exchange market.
Foreign-exchange rates are important to bond buyers who invest globally, as a change in the value of the currency that the bond is issued in can easily overwhelm the performance of the bond itself.
Luke Hickmore, a senior investment manager in fixed income at the $483.3 billion Aberdeen Asset Management, pointed to the importance of hedging currencies in a September interview with Business Insider.
He said that foreign-exchange rates are one of the chief things he keeps his eye on as a bond investor.
“It’s always going to be currencies, right? Currencies, currencies, currencies.”
An appreciating dollar has caught bond investors out, according to Srivastava, who said global funds had dropped in value despite favourable conditions for the bond market itself.
“They have been hurt by the currency,” Srivastava said.
“Most global fixed income funds have a lot more volatility and also have been dropping in returns — negative returns — because of the currency effect,” he said.
Diverging monetary policies and fast-moving foreign exchange rates are forcing investors to evaluate how best to make use of global fixed income in their investment portfolios.
“Some are making the shift out of the US into global, because it offers more diversification — differences in central bank policy” and more opportunities, he said. “And others are just reevaluating their approach — how much currency do they want in global fixed income?”
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