Fixed Income

Is now the promising time for Sterling Corporate Bonds?

Ben Edwards |21-Oct-2016

Sterling’s corporate bond performance has defied expectations with yields falling further, supported by a weakening outlook for global economic activity, Brexit, and the BoE’s rate cut and further monetary stimulus. We see macro and political factors continuing to support yields.

The sterling corporate bond market has produced some impressive returns this year, at odds with the prevailing wisdom, that the first US rate hike would herald the beginning of a return to ‘normal’. Bond yields have fallen further, supported, in turn, by a weakening outlook for global economic activity, the Brexit referendum and finally, a Bank of England rate cut and further monetary stimulus. Part of this stimulus package, the Corporate Bond Purchase Scheme, began last month and will continue to support sector performance and lower borrowing costs for UK companies.

While the “search for yield” theme is still clearly alive and well in this low rate environment, we continue to build portfolios focused on strong companies with proven cash generation ability. We currently favour sterling-denominated bonds compared to low-yielding European counterparts or the ever-expanding US market, where corporates continue to borrow in record amounts. We prefer bonds of shorter maturities, viewing longer-dated corporate securities as offering too little premium compared with their increased volatility. We also carry limited exposure to what appears to be a challenged European banking sector.

We continue to believe that an impressive combination of global central bank action, low potential growth, low inflation, demographics and geopolitical risk will continue to support yields at low levels

As we came out of the quiet summer months, both bond and equity markets were rocked by the expectation that Japan’s central bank would veer away from their QE status quo, allowing longer-dated bond yields to rise. This has largely reversed as the Bank of Japan confirmed that they are looking to target ten-year yields at around 0%. This ongoing conversation about the extent, direction and efficacy of monetary policy, combined with heightened political uncertainty in the UK, Europe and the US, will drive further volatility spikes at a time when central banks are pushing their mandates in order to suppress them.

Nowhere is this more obvious than in the UK where Brexit related uncertainty and the transition from 100% monetary support to some QE/fiscal combination have driven material sterling weakness and volatile gilt yields. While short term volatility has given us tactical opportunities to add government bonds, including gilts, we don’t believe that government bond yields are set to rise dramatically. We continue to believe that an impressive combination of global central bank action, low potential growth, low inflation, demographics and geopolitical risk will continue to support yields at low levels.

Ben Edwards
Director, lead fund manager of BlackRock Corporate Bond Fund and co-manager of the BlackRock Sterling Strategic Bond Fund
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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 17/10/2016 and may change as subsequent conditions vary.

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