The surge in yields at the start of the year could be a sign of things to come as inflation risks start to pick up.
This is according to UBP’s chief strategist Norman Villamin (main picture), who warned that markets are not focused enough on inflation risks.
“Markets are not focusing enough on the prospect of inflation coming back up,” he said at a media briefing in Hong Kong.
Although inflation is widely expected to bottom out this year, UBP expects to see inflation rebound back above 2.5% and potentially closer to 3% by year end.
“This is even before Donald Trump announces what he’s going to do,” Villamin said, alluding to the potential inflationary impact of new immigration and tax policies under Trump.
“Unemployment is very low. Job growth is very strong. And that is despite over the last four years you’ve had effectively 2 million people enter the country illegally and contribute to the workforce,” he said.
He warned that if immigration flows go back to the levels they were between 2010 and 2019, it could lead to one million less people entering the workforce which in an already tight job market creates inflationary pressure on wages.
Bond investors will be faced with higher yields
This is one reason why risks for bond yields are towards the upside, and UBP has a bearish view on both long duration US Treasuries and long duration investment grade credit.
“Last year was a year of rising yields; we think 2025 is again going to be a year of rising yields for dollar bond investors,” Villamin said.
“Managing interest rate risk is going to be key for investors in 2025 especially for bond investors, and as inflation unfolds we think you’ll see continued trending higher in yields through the year.”
Although the bank’s base case for US 10-year yields is 5%, Villamin warned that if additional pressure from tariffs, tax cuts and concerns over a fiscal deficit start to emerge, this number could go higher.
“This is the kind of dynamic you see starting to unfold in the UK today with their new government as they tried to spend. Inflation is still elevated from here, and that’s putting pressure on long term bond yields,” he explained.
UK gilt yields surged recently, with the 10-year yield reaching 4.73% and the 30-year yield hitting 5.4%.
Given the risks ahead, UBP is advising clients to minimise potential capital loss in the bond market by shortening duration and maximising coupons.
“You’re getting a very nice coupon today, which is higher than we’ve had for a long time,” Villamin said. “But that rise in yield is going to eat into your coupon.”
“During the last few years, if you were a bond holder, you got coupon plus capital gain, the risk is as we saw last year, you get coupon minus.”
Investors searching for yield can look towards low duration riskier credit or low duration high yield strategies, he said.
“As we get this ‘higher for a longer yield’ environment going forward, you need to move out towards these poles to generate your yield and protect your bond portfolios from rising bond yields.”
Villamin added that certain hedge fund strategies have historically delivered investment grade like bond returns without interest rate risk, such as relative value arbitrage.
“If we’re right, and bond yields continue to rise from here, then you want to take these fixed income alternative hedge fund strategies, and you’ll generate better performance than you would in investment grade bonds,” he said.
