4 Factors That Could Affect Fixed Income in the Long Term

In today’s challenging bond market, it’s difficult to decide how an investor should get allocation to the space when sorting through the plethora of opportunities available. Whether it’s long or short duration, broad-based or niche, and high yield or investment-grade, there some long-term trends investors need to be wary of prior to allocating capital towards fixed income.

The bond markets threw a curve ball at fixed income investors earlier this year with an inverted yield curve, sending the capital markets overall on another volatile ride–something they may or may not have been accustomed to during the fourth quarter of 2018. The short-term 3-month and longer-term 10-year yield curve inverted–an event that hasn’t been seen since 2007–just ahead of the financial crisis.

The spread between the 3-month and 10-year notes fell below 10 basis points for the first time in over a decade. This strong recession indicator contrasted a more upbeat central bank , but investors were quick to add more caution to their capital allocation.

Given this latest obstacle, fixed income investors now have to get strategic when it comes to the bond markets as well. It’s not just inverted yield curves that are presenting challenges for fixed income investors.

Kristina Hooper, Chief Global Market Strategist at Invesco identified four key trends that could affect the bond markets in the long run.

Trade War Developments

Investors are well aware of the impact of trade wars by now. Hooper cited two positive developments, however, according to Hooper:

  1. The Trump administration will postpone applying auto tariffs on imports from the European Union and Japan for as much as six months.
  2. The Trump administration is eliminating steel tariffs for Canada and Mexico.

“Stocks moved up on the news, as it seemed to indicate that the Trump administration is willing to negotiate and be flexible when it comes to trade negotiations,” Hooper noted. “However, I believe that is a misreading of these developments. I think the US is desperate to take attention away from the deterioration in trade relations between the US and China by providing some positive news flow vis-a-vis trade. In addition, I believe that the US may now realize that traditional allies could help it place pressure on China, and is now trying to win them over after alienating them with trade conflicts of their own.”

US-Iran Tensions

More geopolitical tensions could weigh in on the bond markets, including rising tensions between the U.S. and Iran. It’s not gotten the attention it deserves, but as the U.S.-China trade story fizzles, the Iran story could be peaking.

“The rise in tensions between the US and Iran has largely been overlooked because of the US-China trade situation,” Hooper wrote. “I worry that tensions will continue to rise between the two nations. There is even the potential for an accidental war to start. We will want to follow the situation closely as this has the potential to draw many nations into a major military conflict.”

Gold and Precious Metals

With U.S.-China trade negotiations in limbo, this could cause a flight to more precious metals like gold as investors seek safe havens aside from bonds. Uncorrelated assets like gold ETFs could see more flows as 2019 wears on.

“Similarly, some strategists are suggesting the rise in gold is tied to greater concerns about the breakdown in trade negotiations between the US and China,” Hooper wrote. “This makes sense, in my view, especially given the power of tariffs to be inflationary.”

Bitcoin and Cryptocurrencies

Just as gold can serve as a safe haven, cryptocurrencies like Bitcoin could be viewed in similar fashion. After languishing in the $3,000 range, the leading cryptocurrency broke through $8,000 recently amid the trade war tensions heightening.

“Some strategists are suggesting that the recent rise in bitcoin is tied to growing expectations of a recession to come soon,” Hooper noted. “There is no historical data to follow given that bitcoin is a fairly new creation, and I am very skeptical about this conclusion. However, the ups and downs of bitcoin are well worth following for the messages they could be sending about a variety of market conditions, including how “risk on” or “risk off” capital markets may be.”

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