Bond Watch: why £1 billion flowed into bonds in November

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

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Bonds top the charts

We’ve been writing about bonds becoming an attractive investment again since the summer, and now – although I won’t take all the credit – DIY investors have cottoned on.

The Investment Association (IA) found that Sterling Corporate Bonds was the best-selling investment sector in October, with inflows of £879 million.

In November, Calastone, a fund data group, found that the trend continued, with around £1 billion of inflows into fixed-income funds.

Higher yields are tempting investors back into corporate bond funds, with prospects of interest rate cuts towards the end of next year to stimulate the economy also providing hope of capital gains.

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With inflation forecast to fall next year, investors who are happy to look out a couple of years are able to bag a positive real income from lending money to established companies. Yields have risen over the past year, with the average yield to maturity on sterling corporate bonds now at around 5%.

Investment grade corporate bonds could be a savvy bet in the event of a deep recession due to their reliable income payments. These defensive characteristics could also lead to capital appreciation. Peak interest rates forecast for the first quarter of 2023 and the possibility of rate cuts later in the year are also tailwinds for the asset class.

Signs that inflation is cooling has already sparked a bond market rally over the past month (causing bond yields to fall and bond prices to rise), but investors are betting that there is more good news to come.

Yield curve points to recession

The yield curve in the US and Europe keeps inverting, signalling coming recessions. A yield curve inversion is when longer-dated bonds yield more than shorter-dated bonds – which is uncommon as normally investors demand a greater return to lock up their cash for longer periods.

Higher short-term rates signal concerns about the economy as investor demand a greater return on their cash. The inversion therefore signals that a “soft landing”, where inflation is brought down without a big impact on the economy, is increasingly unlikely.

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Beat Thoma, chief investment officer at Fisch Asset Management, said: “The main driver of the economic slowdown is the persistence of the extremely restrictive global monetary policy with increasingly undesirable side effects, which are also evident in financial markets.

“Structural reasons, such as low debt ratios, solid labour markets and high consumption potential, however, point to only a mild recession. In any case, a further decline in corporate profits is on the horizon.”

Gilt ‘supply glut’ clouds outlook

The UK government is expected to issue a record amount of gilts next year, totalling £255 billion when accounting for gilts that it is selling as part of its quantitative tightening programme. RBC Wealth Management says this will be double the past record set over a decade ago.

This will cause a “supply glut”, the bank argues, which feeds into its negative views on gilts. “The challenge will be whether demand for gilts can meet the supply deluge,” head of fixed income Rufaro Chiriseri said.

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RBC expects the Bank of England to raise interest rates to 4% (from 3% today) by early 2023, below the 4.6% expected by financial markets.

“The recent austerity measures and the upcoming recession will reduce the likelihood for the Bank of England to hike aggressively from here,” Chiriseri said.