Q&A: Where next for bonds, central banks and interest rates?

Bond investors are having to react to some rapidly changing indicators: new forecasts of higher inflation, and signals from central banks that they will raise interest rates sooner than expected, as well as reversing their asset purchase stimulus programmes.

After repeated warnings about high inflation from Bank of England officials, a UK rate rise is now expected in December, with a second increase to follow in February. That would lift the UK base rate to 0.5 per cent — the point at which the central bank would stop reinvesting in bonds under its quantitative easing policy.

Similarly, in the US, consumer prices are now rising at their fastest rate in 13 years, leading the Federal Reserve to acknowledge inflationary pressures from supply chain bottlenecks, as it also prepares to “taper” its $120bn a month asset purchase programme.

With all these factors making fixed-income bonds less attractive, will further sell-offs ensue? If so, which bonds are likely to suffer most? And will Chinese bond default fears cause further contagion in bond markets? Or are these fears overdone?

Tommy Stubbington, the FT’s capital markets correspondent in London, and Kate Duguid, our US capital markets correspondent based in New York, answered your questions about bonds in the comments.

Here are some of the highlights:

FT Commenter AvidFTreader: Are retail bond investors (or bond fund investors) continuing to participate in the market? Is there a possibility that independent investors will leave the market? Where do we go for (near risk free) but decent returns?

Kate Duguid: It’s definitely the case that investors move into riskier assets when yields are low. We’ve seen that in the dramatic narrowing of high yield and investment grade corporate spreads. But there is also so much money sloshing around the system right now that the other major trend we’ve seen is too much money chasing too few assets. I don’t necessarily see investors abandoning government debt markets given that there aren’t other places to go. It may mean that investors do crowd into government debt in countries with slightly higher interest rates - foreign demand for Treasuries has been enormous recently, for example.

FT Commenter KM: Is there still a case for a 60/40 balanced investment portfolio or should one sell the bonds? What other investments would you suggest that offer inflation protection ?

Tommy Stubbington: There has certainly been a lot said recently about the ‘death of 60/40’. If QE has buoyed up stocks and bonds in unison, then surely it’s unwinding will hurt the balanced portfolio at both ends? I think a lot of individual investors have probably already pulled the plug by focusing on equities, or perhaps opening a Robinhood account to trade options, or buying Bitcoin. 

None of these things really replaces the role of bonds in a portfolio of providing a hedge against risk assets and a diversifier. Personally I’m not convinced that the negative correlation between stocks and bonds is dead. The big fixed income rally this summer showed that once bonds have sold off a bit, they have room to rebound and earn holders quite a bit in price gains - so you could argue that 60/40 is dead when yields close in on zero (or wherever we think the lower bound is) but becomes useful again if they rise.

Having said all of that, bonds are definitely not going to repeat the 40 years of gains they’ve just made for investors - so perhaps if they still have role for individuals it’s a smaller one. 

Want more? The conversation happened in the comments below, so read on.