Bond navigators: Are markets ignoring geopolitics?

Markets seem odd sometimes. Once upon a time, the first reaction to something like the US / Iran situation would have been for risk assets to sell off and government bonds to outperform as investors ran for safe havens.

Not any more. In a post-covid, post-QE world helping keep yields low, governments don’t appear trusted to keep spending and deficits under control.

After the initial weakness in March, risk assets have rallied. As my colleague Mike Fox – our Head of Equities – pointed out last week, some of this is because markets are looking at the long-term boost to growth from AI. In credit markets, we’ve seen AI-related issues such as Alphabet’s 100-year bond making headlines, but this is best seen through a marked increase in tech-related energy infrastructure issuance. In simple terms, the tech revolution needs a lot more electricity, and it is not as easy as flicking a switch.

From a credit investor perspective, you can take a half full or half empty approach: first, many of these companies have regulated asset bases and therefore have lower credit risk than other parts of the market; against that, many are issuing hybrid bonds, which are attractive to issuers as these typically only count these as a mix of equity and credit for ratings agencies. It’s one reason we advocate an active approach – ratings agencies help create market inefficiencies that active managers can target.

We’ve mentioned before that ‘risk-free’ government bonds are not being seen that way. Faith in the ability of governments to manage their deficits and borrowing in post-QE, post-Covid world where defence spending also needs to rise is low at best.

Credit is obviously not risk-free either – as a credit investor you take on liquidity risk and credit risk compared to government bonds. Some will be concerned that spreads are too low and could go wider. Obviously if you think a recession is coming then that is a distinct possibility.

But my own view is that while overall growth may be weak, the corporate backdrop is more robust. More importantly, while you are taking that credit risk, you are earning a pretty attractive premium. That is the position that credit can have a portfolio: aiming to compound additional yield over longer time periods.

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