Bonds yields are becoming attractive again

Is it worth it to look at bonds again? For many years while interest rates were at near-zero levels all around the world, active asset managers have been under-allocating to bonds with the expectation that yields would rise and that it would hurt their holdings. Although the exact timing of when to deviate from such a stance is hard to pinpoint, we can now say that bonds are becoming attractive again with short-term investment grade credit yields reaching 5-6% in certain sectors and subordinated debt from the big 6 Canadian banks yielding 8+%. Owning government bonds ranging between 3.5% and 5%, depending on the government level and curve point, is also starting to make much more sense than it did a year ago.

Long-term inflation is the big question mark

It is becoming increasingly clear that, unless we face a severe deflationary spiral, inflation will remain elevated for the foreseeable future (1-2 years). When analyzing bond investments, positive real returns are generally what investors will be seeking. With these two elements in mind, the expectation of reaching that objective given 7-8+% inflation is grim for the next year or so. However, when we go further up on the curve and look 5-7 years in the future, will inflation normalize down to 3-4%? Perhaps to 2% as was historically the case for long-term inflation? In these scenarios, the expectation for positive real returns becomes much more realistic at the current yield levels across the aggregate bond market (credit & governments). This may push investors that had recently shun the idea of allocating to “core” bond strategies with a duration of 7-8 years to revisit positively the attractiveness of these solutions.

Looking at alternatives within the fixed income spectrum

High-yielding, near-zero duration alternative fixed income solutions or core+overlay bond exposures that surpass the elevated inflation rates should continue to be popular in the current environment. However, after a historically tough year for the asset class, we see the entire bond complex benefiting from higher yields across the board.