The global bond markets are on track to encounter tighter liquidity, higher interest rates and bouts of volatility, especially given that central banks are removing stimulus support and hiking rates.
Yet despite this backdrop and the challenging investment environment in general, there is potential for buying opportunities, believes T Rowe Price.
However, this also assumes that investors account for the fact that shifting dynamics mean the past decade is likely to be a poor guide as to how bond markets might perform going forward.
“Faced with rising rates and volatile markets, we believe bond investors will need to think differently and adopt a broader, more flexible approach that emphasises active duration management and volatility management,” said Arif Husain, head of international fixed income and co-chief investment officer for fixed income at the US fund house.
This is essential given that beyond simply navigating a new higher volatility regime, investors will also need to identify when a potential inflection point emerges, he added.
Mitigating rising risks
Following the sharp rise in bond yields in 2022, investors have been questioning how much longer the rout can continue.
According to T Rowe Price, the path to higher rates is likely to be volatile as central banks move at varying speeds to tackle inflation.
As a result, managing duration actively should enable investors to tactically respond to different market environments and regime changes.
“It also gives investors the flexibility to take advantage of any pricing anomalies and dislocations that might occur in a volatile environment,” explained Husain.
Investors must also take a broad approach with the scope to invest in different bond markets across the globe, he added. “It offers opportunities to take advantage of scenarios where policy is diverging.”
Adapting to a new reality
More generally, fixed income markets are also undergoing a period of strategic change as central banks retreat from supporting markets.
“The changing market environment means that investors can no longer rely on the post‑global financial crisis investment playbook and will need to think and act differently going forward,” added Husain.
For example, he suggests investors should no longer assume fixed income will always be a diversifying asset class that typically performs well when risk markets such as equities sell off. This has been seen at multiple times this year already, when stocks and bonds have both sold off simultaneously.
“A broad approach that deploys the full toolkit, including currency and derivatives markets, may help to balance and mitigate risks in a portfolio,” he explained.