Schroder Investment: How to manage bond portfolio risks in the face of changing interest rate expectations?

According to the Zhitong Finance APP, on July 8th, Wu Meiyan, the Director of Fixed Income Investments at Schroders Investment Management in Hong Kong, stated that since 2024, the inflation data in the United States has been fluctuating, leading to uncertainty in the financial markets about the Fed's interest rate cuts, and even concerns about the increased possibility of the economy not landing smoothly. Currently, the interest rate market continues the high volatility seen in the first quarter of this year, affecting the performance of the bond market. The most concerning issue for bond investors has always been when the Fed will cut interest rates and by how much.

Wu Meiyan mentioned that instead of speculating on the timing of interest rate cuts, bond investors should use flexible investment strategies and actively control the risks brought by interest rate fluctuations through different types of bonds, which may be more suitable for the rapidly changing investment environment.

Although there have been fluctuations in inflation data in individual months in the United States recently, Wu Meiyan believes that the overall direction of the U.S. economy is still steadily moving towards a "soft landing". As the economy continues to grow, inflation is gradually slowing down. The Fed is still expected to cut interest rates this year, but the timing of the rate cut is slightly delayed compared to the market's initial expectations.

Currently, the scenario of the U.S. economy not landing smoothly is not the basic prediction of Schroders Investment. Wu Meiyan also believes that the U.S. will maintain a relatively high level of inflation, the job market is not overheated, the probability of the economy being stronger than expected is relatively low, but financial market sentiment may become tense again with the repeated economic data. Therefore, in managing interest rate risks, bond investors must remain flexible.

From the perspective of bond investment portfolios, as the U.S. Treasury yield curve continues to be inverted, with short-term rates higher than long-term rates, Wu Meiyan currently prefers short to medium-term bonds. In the current situation, assuming that interest rates will remain at relatively high levels for some time, short to medium-term bonds will better control interest rate risks.

Wu Meiyan stated that unless the U.S. economy faces a serious risk of recession, forcing the Fed to significantly cut interest rates, increasing the holding period of bonds prematurely will lead to interest rate risks. Even if the pace of rate cuts in the U.S. is not as expected by the financial markets, investors will still face relatively high interest rate risks, affecting overall investment returns. In addition, a U.S. economic recession is not the current basic prediction.

In addition to flexibly managing interest rate risks, investors should also diversify their investments in different types of bonds and expand into bond markets outside the United States. In fact, since 2024, European corporate bonds have outperformed U.S. corporate bonds.

From a valuation perspective, Wu Meiyan believes that the valuation of U.S. dollar bonds is relatively high at the moment, with credit spreads close to the long-term historical average level, indicating that the space for further narrowing credit spreads to gain additional return has become smaller. In contrast, investment-grade and high-yield bonds in the Eurozone are more attractive, as their credit spreads still have room to narrow, potentially bringing returns to investors.

Most investment-grade Eurozone bonds are issued by financial institutions, with other issuers including large luxury goods companies, real estate companies, and car manufacturers. Among European real estate companies, Schroders Investment is optimistic about the prospects of the European logistics industry benefiting from the trend of deglobalization Currently, Schroder Investment Management is more optimistic about investment-grade bonds issued by European financial institutions because of their relatively wide range of business operations, stable income sources, and lower likelihood of experiencing liquidity risks similar to those of regional banks in the United States, as well as higher credit ratings