Investor focus should be on fixed income yield curves

Antoine Lesné, Emea head of ETF strategy at SPDR ETFs

Last year’s ECB actions and investors pushed 10 year German government bond yield to levels unseen in modern financial history down to 0.05% intra in April 2015.

In a world of European Central Bank quantitative easing, and with the Federal Reserve (Fed) now tightening policy (SSGA economists forecast there will be a series of four quarter-point rate hikes this year) choosing whether to invest across the entire yield curve or only in certain segments will be of critical importance.

This is because, dependent on where in the yield curve you choose to invest can have a drastic impact on a bond portfolio’s returns.

Historical returns across US and eurozone bond markets
For example, between 1995 and 2015 the Barclays US Treasury (UST) index returned 217%, but with significant variability across the curve; the 1-3 year index returned 125%, while the 10-year plus index returned 410%1.

A similar pattern was observed in the eurozone government bond market. From the creation of the single currency to the end of 2015 the Barclays Euro Treasury index returned 126%, compared to just 72% for the 1-3 year index and more than 195% for the 10-year plus index2.

Of course, with developed country yields on a downward trend since the mid-1980s it is no surprise greater duration risk led to higher returns. However, investors in long-dated bonds did not see superior returns in every year, and with the Fed now tightening policy it is useful to consider how the markets behaved during previous hiking cycles.

Behaviour of US Treasuries during past Federal Reserve hiking cycles
All recent Fed hiking cycles (see chart 1) have been characterised by rising yields and a flattening of the curve (chart 2), but the experience for Treasury investors varied significantly (see chart 2). The 1994-95 hiking cycle was clearly the most difficult; with losses across every curve segment apart from the 1-3 year sector.

By contrast – somewhat surprisingly –all the indices saw positive returns during the two most recent hiking cycles. While the best of these came from the 10-year plus sector, the 1-3 year index also performed strongly during the 1999-00 cycle.

Chart 1: Federal Reserve hiking cycles

Start date End date Start rate End rate
04 Feb 94 01 Feb 95 3.00% 6.00%
30 Jun 99 16 May 00 4.75% 6.50%
30 Jun 04 29 Jun 06 1.00% 5.25%

Source: Bloomberg

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