Market Comment: The impact of higher yields on your bond portfolio

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In the past few weeks, we have witnessed a sell-off in bond markets. Bond yields soared as markets priced in higher inflation expectations and a faster pace of central bank rate hikes. We asked Chris Huijs, fixed income expert at ABN AMRO Private Banking, about the impact of rising yields on bond portfolios.

Chris, for a long time, we have had a negative view on bonds. Now that yields are moving up, do you think it’s time to take a different stance?

Yes, we are moving towards the point at which government bonds become appealing again. After a long period in which negative bond yields were no exception, we now see bond markets gradually becoming more attractive. Yields on 10-year Bunds, for instance, dropped below zero in 2016. Since then, they edged almost 1% higher, to a current level of around 0.7%.

Do you think there is a risk of bond yields rising faster than we expect?

Yields move inversely to prices: when bond yields rise, prices fall. And it doesn’t feel comfortable to buy into something when prices are still falling. So, the timing issue is always a challenge. But we think that most of the recent bond sell-off is behind us. Our economists this week upwardly adjusted their yield forecasts for 2018. Their new forecasts represent a relatively moderate yield increase from current levels.

What should investors do?

It seems likely that in the near future, we will suggest investors to scale back their cash position and to start selectively buying government bonds again – by adding, for instance, specific peripheral government bonds.

Bear in mind, however, that circa 30% of the market still offers below-zero yields, so the era of negative bond yields isn’t exactly over. This calls for a selective approach when re-entering the government bond market. If we were to suggest investors to start buying government bonds again, we would advise them to tread carefully as far as the duration (interest-rate sensitivity) of their bond portfolios is concerned. Bonds with longer maturities are generally more sensitive to higher interest rates.