Fixed Income Outlook 2022: Low yields and omicron impact

Low interest rate environment continues to present challenges for the bond market


Natalie Kenway

Fixed income fund managers running responsibly invested mandates have pointed to yield curves, Federal Reserve announcements and the latest coronavirus variant as factors that will significantly influence bond markets this year.

The commentators agreed sustainability will continue to be an important and growing area of fixed income, with impact bonds highlighted in particular, but market uncertainty and low interest rate environment continues to present challenges for the broader asset class overall.

Here, ESG investment professionals shared their insights with ESG Clarity:

Andrew Lake, head of fixed income at Mirabaud Asset Management

ESG will continue to be an important growth area for fixed income (FI), as both clients and buyside firms focus and align their processes and investment outcomes to have more ESG exposure.

See also: – Green Dream with Mirabaud’s Andrew Lake: Engaging and challenging the highest emitters

We need more consistent messaging and alignment so that investors are able to choose the funds that are walking the walk and not just talking the talk. The growth of sustainability within FI has been rapid and there will always be some catch up needed from regulators and investment firms. I would also hope to see a larger range of relevant indices being made available to investors.

In terms of challenges for the asset class, low yields continue to be problematic. The opportunities for returns in a low interest rate environment are harder to find and thus traditional FI investors are either having to revise their expected returns downward or taker more risk. As we see the withdrawal of central bank liquidity I would expect to see more volatility and thus opportunity for active managers across different segments of fixed income.

I think 2022 will be more focused on active management within FI, as the need to differentiate in order to generate returns will be paramount. The expectation of higher yields as a result of potential interest rises in the US will be key to FI performance in 2022. ESG/sustainability will continue to exponentially grow as both lenders and borrowers focus upon this area.

Nimisha Sodha, head of ESG at FE Investments

Green bonds continue to dominate but in 2021 we also saw the issuance of impact bonds more than double when comparing the year’s figures with 2020 and social bond issuance also accelerated as well. This in turn could lead to a wider variety of ESG bond strategies becoming available in 2022. To date, the vast majority have been standard corporate bonds fund which are easy to implement in an ESG process, but lots of managers have announced new products that are coming to market that are more strategic in nature, investing in a range of credit instruments and sovereign bonds.

One of the biggest challenges for impact bonds is being able to monitor and aggregate data. We have already seen the inherent difficulty of obtaining meaningful ESG data for the industry as a whole, but impact bonds cover a wide variety of strategies, so it becomes an even trickier proposition. The cost of impact bonds is also something to consider. While most come at a premium, which although doesn’t seem to be having any immediate effect on investor capital flows or interest, has drawn some reservations from some fund managers, who have cited the cost of recent issuances for their reluctance to purchase.

The key aspect for managers who are looking to differentiate themselves is through company engagement (typically more difficult for creditors than equity holders) but recently, more have been able to demonstrate effective engagement.

James Athey, investment director, abrdn

After 2020 and 2021, I reckon most investors would kill for a quiet, grinding, trending rally to sit back and enjoy. Unfortunately, I can’t see it. The reality is that there are still gigantic forces at play and they are pushing and pulling markets in very different directions. I’ve given up trying to espouse the need for some froth to come out of equity valuations – the market is a momentum machine driven by passive inflows, systematic investors, gamma and the near-universal belief in the omnipotence of the Federal Reserve. Who am I to point out the folly in all of that. However, it seems near-guaranteed that the Fed will be taking away the punchbowl next year – and if that’s not true I can only envisage that’s because the economy takes a swan-dive.

The omicron variant has the potential to be a pandemic-ender in my opinion. The virus won’t go away but the end game seems inevitably to be another virus to add into the basket we call “flu”.

All of which leads me to believe a flatter yield curve is the obvious way to play such heightened uncertainty. If 10y yields can’t get above 1.75% when market consensus during Q1 was so universal and universally bullish (fiscal Rubicons crossed, dovish-policy-for-ever, virus-beating vaccination, Smaug-esque savings etc), then I really struggle to see why they’d be materially north of there when the downside risks seem so prevalent. Meanwhile, the Fed is way behind the curve and scrambling to catch up. 2y yields at 0.6% look very rich in such a context. That should all mean a stronger dollar. The dollar smile wings are fat. The centre is tiny and shrinking as China and the Eurozone continue to walk into the wind.

Tighter policy, stronger dollar? Did I say I was finished with my bearish equity forecasts? Well that didn’t last long.

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