Lessons from growth investing

Rising bond yields are attracting increasing interest from multi-asset investors despite wider fears about inflation and the potential for economic recession, says Newton¹ head of mixed assets investment Paul Flood.

After years of low inflation amid positive central bank market intervention, global investors are facing a profound shift in market conditions.

The return of inflation means that after more than 10 years of struggling to bring inflation up to target, central banks now face a different challenge. Recent months have seen central bankers repeatedly hike interest rates in order to quell stubbornly persistent and rising inflationary pressures.

For Newton’s Paul Flood, recent macroeconomic trends emphasise the need for independent thinking and analysis. While economic experts abound, he argues, few predicted the abrupt shift from near zero inflation to the current, persistently high levels.

“As investors we surround ourselves with experts but they are not always right. The Bank of England’s prediction that we would see only a brief transitory rise in inflation, before we realised otherwise, is a good example of this. Whatever the experts tell us, we believe a detached, detailed independent analysis can provide a really useful reality check on market conditions,” he says.

Recessionary fears

While Flood is concerned by some market indicators, such as a current inversion of the yield curve and spiralling wage growth, he is more positive on the likelihood of inflation tapering off to lower levels in the months ahead as central bank interest rates rises start to bite.

“While we may not be out of the woods yet in terms of further interest rate rises – and while the current yield curve inversion is worrisome and generally indicative of delayed recession – we expect to see inflation come down quite markedly across markets.

“US ‘break-even’ rates suggests the market believes the US Federal Reserve can bring inflation back down to target. We may even see inflation fall in the UK, a market which has tended to see significantly higher inflation levels than some other economies.”

For all this, Flood believes markets are unlikely to see a return to near zero rates any time soon. Deglobalisation and its impact on global supply chains and rising commodity costs, he adds, are just some factors likely to fuel persistently higher inflation levels.

However, Flood believes current market conditions could hold a silver lining for bond markets as fixed income assets offer investors higher yields and provide better diversification as part of multi-asset portfolios.

“We are seeing some of the highest bond yields since the financial crisis. Overall, in light of this, we believe bonds are buyable again, both in terms of their potential to generate returns and for diversification purposes. In broader economic terms, the real-world impact of monetary tightening isn’t quite biting yet, but we expect to see its effects starting to take hold by the end of this year.

“If and when the economy does eventually roll over, it could create an environment in which equities do less well. In this scenario we think government bonds should offer better diversification, particularly in relation to their plight in 2022 when bond markets suffered some major losses,” he concludes.

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Footnotes

1: Investment Managers are appointed by BNY Mellon Investment Management EMEA Limited (BNYMIM EMEA), BNY Mellon Fund Managers Limited (BNYMFM), BNY Mellon Fund Management (Luxembourg) S.A. (BNY MFML) or affiliated fund operating companies to undertake portfolio management activities in relation to contracts for products and services entered into by clients with BNYMIM EMEA, BNY MFML or the BNY Mellon funds.