Here to stay? Low interest rates and fixed income investing

John Walbaum: I think rates will rise eventually but they are going to stay low for quite a long time. I have been told by many people for many years now that rates cannot go any lower, but they keep going lower for a very good reason I think. It is really hard to see much in the way of inflationary pressure around the world. And the logic for a raise in rates does not seem to be there.

Chris Redmond: Base rates low for longer than the market predicts, longer than most markets predict. And, consequently, that leads you to a position that is slightly strange to say, but with a value in gilts.

Edward Farley: Levels of 1 per cent and 2 per cent growth are probably here to stay for a while. People look at global growth and they get very excited if they saw a GDP number of 3 per cent. So if you put that type of growth in context, it is very difficult to see rates going up.

And then when you have negative rates in the eurozone all the way out to seven, eight years, certainly German bunds, you have negative rates in Japan, it is very difficult for other developed markets rates to rise when there is that gravitational pull that will keep rates low, certainly for the foreseeable future.

Simon Cohen: I suppose the concern is that we end up in a situation like Japan, and people have been talking about that. I just cannot see them going up in the short to medium term.

The question is at what point do the authorities decide that this is not working and they are going to have to do something else. For example, use fiscal policy to try and stimulate growth because at the moment the focus has been on monetary policy and it does not appear to necessarily be working.

Joe Abrams: In the next five to 10 years I think rates will be low. In the longer term perhaps there is a lot of uncertainty because we have had experiments like quantitative easing and negative interest rates. I suppose there is room for a little bit of rate rising in the medium term, but even if you were to see nominal take in gilts at 2.5 per cent to 3 per cent, I would still class that as low. 

You have to look at the world in terms of different pockets of opportunity. I think a lot of investors have been very beholden to things like benchmarks, and there is a lot of scope to look for pockets of opportunity and have the flexibility to take advantage of opportunities.

It can be key to having governance frameworks in place which do take advantage of periods of volatility in rates for liability hedging purposes, or invest in strategies which can look at different parts of the fixed income landscape which is not defined by simply a benchmark construct and being able to take advantage of those pockets of opportunity.

Redmond: From an active management perspective, a fantastic environment is likely to ensue. We have the beginnings of dispersion in policy, albeit only the Federal Reserve has actually formally raised rates, but the tapering of QE is a soft form of monetary policy, and you can see already the influence of that. 

So literally to the day that QE tapering began, the credit market began to crack.  There has been pretty consistent unwinding in credit spreads since then.

For the end saver, and for the pension fund manager perspective, it is going to really bring into question that decision around, ‘Should I hedge, have I hedged enough, should I capitulate now, how is that going to feel, how big is the trade I have on to be short[?] of credit risk and when should I neutralise that? Am I comfortable with the magnitude of that?’

Abrams: I think active management will now be at a premium as well. We have seen seven or eight years where we have had different bond yields falling and loads of managers have not looked at rates simply because bond yields have been falling. A diversified exposure to these different bond meters has done quite well.

So I think while loads of managers have done well in that environment, it is important to look for managers who have the mindset to be able to deliver an objective in the different environment.

Walbaum: The other thing that is interesting here, and you mentioned hedging, the average hedge ratio in the UK seems to be around the 40 per cent level. And if that is true, then on average we have got that horribly wrong. 

The reason we have massive deficits is because we have not protected ourselves against rates being low for longer. If we are all sitting here saying rates are going to stay low for longer, and potentially lower than the market is predicting, then this remains one of the biggest bets that pensions schemes are taking.

And perhaps this is the time for people to think about a more mechanistic approach to getting yourself back to a sensible position. 

Farley: Bond investors crave certainty and transparency, which is obviously very difficult, especially when central banks go off and surprise markets. 

If you take the Fed, for example, one of the things the markets did not like was not quite knowing what the Fed’s objectives were and what they wanted to do. It was very clear the Fed wanted to raise rates but equally they did not quite know how to do it and how to communicate that to the market. 

It is clear that the Fed wants to continue to raise rates, but if they can do that while expressing to the market that they believe rates will be low for a long time, that any rate rises will be very gradual and slow, then actually the market can perceive this two ways. They can: one, have a panic like they have done before – ‘Oh my word, rates are going to go up; that is a bad environment for the price on bonds’; or they can say, ‘Wow, we can raise rates, the US economy has decent growth; it is meant to be 2‑2.5 per cent this year.’ 

If it is more constructive then it is 3 per cent and I think that is an outlier of a number.  But if the Fed can raise rates because you have a strong economic growth, that might be an okay signal for the bond markets.

It is very clear that in the UK we are not there yet. People think that keep on pushing out when rate rises will go up, there is uncertainty and then there is Brexit thrown into the mix in June, and all these things begin to cloud any particular certainty that you may have and that, in terms of what other people were saying, leads to opportunities as you get dispersions in pricing. 

But at least if you believe that rates, certainly in the UK, are low for longer you know the boundaries with which you are operating in.