Markets across the world are throwing up some interesting predicaments at the moment.
The desire for investment safety is alive and well in the bond (debt) markets across the globe. This week bond prices, in a 'flight-to-safety', have been bid up to record highs, which means yields are at record lows. In some cases yields are actually negative.
Brexit and Italy's banking stability are the most recent concerns driving yields lower.
We don't foresee this situation reversing in the short term. But we are also conscious that there is risk in the current predicament. If, for example, inflation was to unexpectedly rise, we would likely see interest rates respond. If this was to occur, it would likely be in a small way, but with a really meaningful impact.
Other factors that could surprise bond markets are less central bank stimulus / quantitative easing than anticipated, and growth rates higher than predicted.
The following graph depicts how a 1% increase in interest rates in Australia would equate to a 15% capital loss for investors in an Australian government issued bond. I.e. a fairly small movement in interest rates equates to a substantial capital loss.
Investors are buying bonds often as a flight to safety, when in fact they are taking on substantial risk in the event that the world is not quite as bad as they fear.
This situation is magnified for many overseas issued bonds - especially for those that have longer maturities and lower yields.
First Samuel clients do not own government bonds (Australian or overseas) in any of the investment allocations. Hence, this risk is not one directly born by clients. That said, we are mindful of risks such as these, as should they materialise, far reaching and indirect consequences can arise.