The global investment house said bond yield levels are being kept artificially low by the US Federal Reserve’s continuing quantitative easing (QE).
“Why are yields where they are? Because the Fed/government wants them to be there. That is the whole point about quantitative easing - it brings down borrowing costs,” said Andrew Weir, international bond portfolio manager for Fidelity International.
“The depression of yields by the government’s purchasing of bonds is not a revelation; it’s really an economic fundamental. But the key thing for Fidelity is how this relates to employment levels in the US,” Mr Weir told InvestorDaily.
In December, the Federal Reserve said a 6.5 percent unemployment rate would trigger a tightening of monetary policy and raising of interest rates.
“This is a pretty big change for the Fed, rather than the market having uncertainty from month to month,” he said.
The US unemployment rate currently stands at 7.5 per cent and has been showing signs of decline, with strong corporate and housing data coming out of the country.
Fidelity points out this rate will likely move down by late 2014, eventually hitting the Fed’s target.
“I think unemployment is going to be ticketing down and by this time next year, it will be below seven [per cent]... So at that point, QE has got to stop and then you’ve got to see rates drifting up,” Mr Weir said.
When this happens, all things being equal, yield prices are set to rise.
“Longer term, one would have to expect yields to go up, so I am not retraining as an equity fund manager yet,” Mr Weir said.
Reading how the market prices bonds as we get closer to the Fed’s unemployment target will be increasingly important in fund managers' fixed income allocations.
“The problem at the moment is that there is no obvious clearing price. If I want to sell bonds, it’s the Fed who is buying them,” Mr Weir said.
“The price at which I sell is not a market level and you only get a conception of the market level, the clearing price, when the Fed is out of the game.”
He warned that reading this could be difficult if “politicians mess it up” or there is “a spike in inflation”. Nor is this just a concern for fixed income holders. The tapering off of QE is likely to have a strong effect on equity allocations too.
“Equities have been on this ride, this testosterone ride,” Mr Weir pointed out, adding that “this liquidity has been pumped in and equity markets have to decide if this growth is going to be sustained or are they worried that the growth will not survive the lack of quantitative easing.”
