A just-published report examined prospects for all the major financial markets for next year, and updated our investment strategy. One specific area that holds the potential to surprise investors in 2021 is fixed income, as the likelihood for higher government bond yields has increased markedly of late.
So far, central banks have kept government bond yields pinned down near record lows, even as economic activity has rebounded. Most investors believe that policy rates will be left unchanged for a long time, keeping bond yields depressed. Thus, the danger is that this assumption may prove wrong: if the Fed and other central banks succeed in stimulating a sustainable recovery and, eventually, cause inflation to rise, then this will become problematic for fixed-income markets.
Inflation expectations have already perked up and our analyses point to government bonds generating losses next year, as yields gradually rise. We are staying underweight government bonds within multi-asset and fixed-income portfolios, and overweight credit within fixed income, although absolute returns will be low. For equities and other risk assets, the danger will come when the rise in bond yields turns disorderly – not an imminent threat, but something to keep an eye on down the road.