Solutions for a higher-rate environment

FIXED INCOME 5 october 20232 MIN READ

Navigating higher rates for longer: Short-term bonds to the rescue!

In both the US and Europe, headline inflation – inflation that includes fuel and food prices – continues to decline. Core inflation – which excludes fuel and food prices – though, is proving stubbornly sticky, currently standing at 4.3% in the US and 4.5% in Europe¹. And with central banks resolute in a quest to bring core inflation down to their two percent targets, the fight is clearly not yet over. As such, rates are likely to stay at an elevated level for longer and the possibility of further rate hikes persists.

Bond investors may understandably be concerned about the possible impact on their portfolios. Rising interest rates can potentially have a detrimental effect on fixed income portfolios, at least in the short term, by adding to downside risks for bond prices, particularly those of longer-dated bonds, which bear a higher sensitivity to changes in interest-rate levels.

In this uncertain environment, managing duration – a key indicator of a bond’s sensitivity to interest rates – is key. To this end, shorter duration strategies (investing in bonds with a short maturity) may help mitigate volatility and reduce interest-rate risk in a fixed income allocation. In current market conditions, they also offer the potential for attractive yields.

Attractive yields for short duration in a volatile market

Short-dated bonds bring stable income stream

Stability and income are key factors to consider for investors who hold government bonds for diversification purposes and US treasuries and European government bonds currently present potentially attractive and steady yield opportunities, following an extended period of low interest rates.

In particular, short-dated treasuries in the US and short-dated government bonds in Europe currently offer high coupon levels with minimal volatility risk. For example, 2-year government bond yields are currently standing around 3.2% in Europe (German Bund) and 5.0% in the US (Treasuries) – their highest level in over a decade.

Within the credit landscape, higher-quality investment-grade debt is also currently looking attractive, offering the potential to generate stable cash flows. In particular, European shorter-duration investment-grade bonds. With the ECB’s reluctance to give up on its fight against inflation, a lack of visibility on the future path of rates, but a strong likelihood that they will remain elevated for longer, these are far less exposed to interest-rate risk compared to their longer maturity counterparts.

Looking ahead, the transition towards higher funding costs is likely to be faster and more painful for high-yield-rated corporates, which have less ability to generate cash flows and higher short-term refinancing needs. In our view, high-yield spreads are tight and not consistent with the prospects of lower growth in the period ahead.

Risk reward profile of selected bond indices

In the current, uncertain environment, where rates are likely to stay higher-for-longer, managing duration is critical to reducing risk, and it may also be a source of performance. Shorter duration strategies can help protect portfolios against rising rates and may also provide attractive income opportunities.

Amundi ETF offers a comprehensive €7 billion AUM² range of short-term fixed income ETFs, covering government and corporate bonds with different levels of maturities: from daily solutions with zero duration, 0 to 6 months, and up to three years’ maturity investments, catering to different aims and risk levels.

For more information:

Visit our Fixed Income page
Watch our video on navigating higher-for-longer rates

1. Source: Bloomberg, September 2023
2. Source: Amundi, as at September 2023

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