Since the election, 10-year U.S. Treasury yields have spiked more than 100 basis points from the 2016 low, and we have seen the most violent move in bonds since 2013's "Taper Tantrum." The MOVE Index, which measures volatility in bonds, is now back to the upper end of its recent range. For Kathleen C. Gaffney, CFA, Co-Director of Diversified Fixed Income at Eaton Vance, it is clear that volatility is returning to fixed-income markets.
"But with inflation expectations climbing and a focus on both future fiscal policy and tax reform, it is clear that bond investors should be prepared for a lot more volatility." She states adding that "Markets, of course, do not like uncertainty. So while President-elect Donald Trump and his new administration represent the change the U.S. electorate wanted, this change is unprecedented and unorthodox. It is difficult to gauge what risk premiums should be, particularly since quantitative easing and the resulting reach for yield has sapped nearly all the value from the market. And to be sure, we do not know the specifics of any policy program yet."
But this phenomenon isn't isolated to the U.S. It's truly a global change, as evidenced by Italy's referendum vote. According to Gaffney, a lack of growth has led to an increase in populism around the world, and these two trends will be evident across the developed markets.
So how can investors prepare themselves now for more volatility? The specialist believes common sense would have investors moving money to sectors and securities that have historically displayed low volatility, such as U.S. Treasurys and high-quality corporate bonds. Since Trump's win (a short time series, admittedly), U.S. Treasurys and high-grade bonds have slumped nearly 3%. Hiding in traditionally "safe" or "low-volatility" fixed-income asset classes has resulted in portfolio pain.
"We have been expecting and are positioned for a transition from an emphasis on monetary policy towards fiscal policy. I believe a flexible approach is called for, one that can avoid potentially volatile areas of the bond markets. That means staying diversified and selective as value opportunities arise. Bottom line: I believe we are headed for an environment of stronger growth and rising inflation. But uncertainty due to a shifting political environment will continue to spur volatility. I think investors would be wise to use this volatility to their advantage, keeping a focus on the long term in order to stay patient as they wait for opportunities to unfold. I think there has never been a better time to focus on active strategies in fixed income." She concluded.