Bonds (November 2017)

Expect Modest Returns

“The move away from the multi-year policy of quantitative easing among most global central banks, will take away one of the long-standing pillars underpinning fixed income performance.”

– Vasu Menon, Senior Investment Strategist, Wealth Management Singapore, OCBC Bank

Policy interest rates are slowly heading up and the previously abundant supply of liquidity is starting to taper off. This is likely to be a challenging environment, especially with investment grade bonds. However, a gradual, well-orchestrated and well-telegraphed move upward in rates should not prove too deleterious for fixed income performance. Nevertheless with rich valuations and U.S. Treasury yields poised to move higher, expect modest returns over the next few years.

United States

U.S. 10-year Treasury yields are near the top of the narrow range seen for most of this year, as prospects for continued Fed tightening have forced a reversal from the early September lows. However, even if the Fed gives increasingly clear signals that it will hike rates again in December (as we believe), recent history suggests markets will remain unconvinced about the pace of tightening in 2018 (when we expect three more hikes). As a result, bond yields are likely to grind higher, rather than step up suddenly.


The European Central Bank (ECB) announced plans to reduce its asset purchases in 2018, scaling back from €60bn per month to €30bn until next September, with the possibility of an extension.

The length of the planned purchases is more important than the size, because the ECB has said that it will not raise interest rates until after its quantitative easing (QE) programme is over. Markets were buoyed, the Euro hurt by the implication that the first rate hike will not be until 1H 2019, and perhaps even later.

Unlike the Fed, there is clearly a substantial (German-centred) group inside the ECB that is uncomfortable with current policy settings. The economy is reviving and inflation is starting to rebound and ECB President Draghi will face constant pressure to move more rapidly than markets expect.


Central banks in other developed markets are starting to join the Fed in raising rates. Canada has already moved twice, with more to come, while the U.K. could follow. Australia and Sweden are perhaps six months away while Japan only tightens at some distant point in the future.

With the Fed and the ECB announcing plans to cut back on asset purchases in 2018, G3 central bank balance sheets are likely to peak by 3Q 2018. The progressive deterioration of the supply-demand balance is another argument for an upwards drift in bond yields. U.S. tax cuts – if they happen – could also contribute to the supply of bonds, as well as pressing the Fed to raise short-term interest rates more quickly.