Fixed income to remain attractive source of income, says Fidelity Worldwide’s Andrew Wells

Andrew Wells, global CIO Fixed Income at Fidelity Worldwide Investment has outlined reasons why he believes fixed income should continue to remain an attractive source of income.

How would you describe today’s fixed income asset class?

I believe yields across fixed income will stay low for some time. While bonds appear expensive relative to history, refinancing bonds is very straightforward and we’re seeing stability in fixed income markets that we haven’t seen for a long time. You have to consider the current backdrop of banks shrinking their balance sheets, lots of investors looking for income-based solutions and central banks maintaining very accommodative monetary policies. So, if you expect a low-inflation environment to continue, you could argue that bonds are still a good source of income. This is particularly the case where there is central bank commitment to quantitative easing (QE) and we can see interest rates remaining low.

Is there any risk of bond market upheaval?

The US Federal Reserve has learned an important lesson that its eventual exit from QE will have to be extremely well managed and communicated to the market. This is to avoid a repeat of last year’s so-called ‘taper tantrum’. Most fixed income investors are aware that the QE exit point is coming. However, the ongoing tapering process offers a degree of stability in the meantime. Interest rate increases are then likely from mid-2015, but these will need to be handled in a measured and well-articulated way. The Fed should seek to avoid causing market disruption while transitioning to normal interest rates at some stage in the future.

Do you believe the US economy is still reliant on central banking?

Central banks continue to perform many different functions and clearly the US economy still needs help to improve its employment situation. The quality of jobs generated in this cycle has not been great – many jobs are part-time, the participation rate is low – and the soft labour market is still holding back GDP growth. So, there are good reasons why QE stimulus is still needed. However, I’m seeing pockets of potential inflation appear as demand is stoking wage growth, particularly in specialised and skilled areas of the labour force. Overall, however, inflation is still below the Fed’s target.

Ultimately, the Fed is focused on achieving a more stable jobs environment and the understandable consequence will be some inflation. I think the Fed – and Janet Yellen in particular – will be happy to be behind the curve. Higher inflation is likely in 2015 and 2016, which may then be addressed by overshooting interest rate rises to rein in inflation. This approach will be worth it if it achieves a better and broader job market recovery over the long term.

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