AXA IM’s Iggo considers the impact of recent monetary policy developments on fixed income
Chris Iggo, CIO of Fixed Income at AXA Investment Managers, has considered the impact of recent monetary policy decisions, and the relative attractiveness of short duration credit and high yield.
Central banks around the world are now taking additional steps to stimulate credit growth. The Bank of England’s monetary policy committee discussed the possibility of reducing Bank rate from 0.5%and decided instead to extend the asset purchase programme.
The ECB reduced both its main refinancing rate and the interest rate on its deposit facility to zero recently, and the Federal Reserve has also considered reducing to zero the rate payable on banks’ excess reserves.
Many of these measures are designed to reduce the attractiveness for banks of keeping excess liquidity on account at the central bank, and instead to encourage banks to use these reserves to lend to the real economy. Central banks have provided long term funding to the banking sector and are now taking steps to encourage that the funding is not just hoarded but used to stimulate economic activity.
This action has driven short term government bond yields even lower. Banks may not be holding as much in their accounts at central banks but they are holding short term government bonds and Treasury bills. This has driven some yields into negative territory. The 2-yr German government bonds currently have a yield to maturity which is negative and the situation is similar in the Netherlands, Finland, France, Denmark and Switzerland.
An additional consequence is that many money market funds have had to restrict or limit new investments to protect the interests of existing investors.
So what are investors considering? Many are forced to hold government bonds for ratings, duration and liquidity reasons – mostly banks – but other investors are clearly searching for assets that do not have negative yields. The obvious next step is short duration investment grade and high yield corporate bonds. The yield differential on short maturity credit relative to government bonds is as much as 2% to 2.5% in Europe and over 3% in the UK. In high yield, the yield differential is closer to 6%. In the US, short duration high yield is a multiple of the return available on US Treasuries.
It is clear that the monetary environment is going to remain extremely accommodative for some time. While there are significant economic uncertainties and ongoing concerns about the situation in Europe, short duration credit is one potential solution for investors that want to generate higher levels of income relative to cash.