Bonds could suffer a 90s-style crash, says veteran manager

Forward guidance and unprecedented levels of quantitative easing have caused a dangerous dislocation in fixed income markets, according to bond fund manager Bill Eigen.

Eigen, who is head of absolute return and opportunistic fixed income strategies at JPMorgan Asset Management, argues that the economic interventions of central banks since 2008 has driven bonds away from economic and company fundamentals, leading to a potentially explosive situation.

"The Federal Reserve and other central banks around the world have broken fixed income markets. US bonds now react to what [European Central Bank president] Mario Draghi says rather than to any of the economic realities in the US where growth is strong and unemployment is down," says Eigen.

'Blow up' in bonds

"A market where real fixed-income yields are 0.45% is one that is essentially saying that it doesn't believe what the Fed is telling it despite the bank being very clear that its intention is to raise interest rates."

Arguing the bond bear case, Eigen says he is convinced that US interest rates will rise next year. Subsequently, he claims we could see a "blow up" in bonds the likes of which hasn't been witnessed since 1994 when a surprise interest rate rise in the US led to a loss of $1.5 trillion (£957 billion) in global fixed income markets between January and September.

"I am more nervous now than I have been at any other time since I started in this business in 1990," says Eigen, who currently has 60% of his portfolio in cash with the remainder in high-yield bonds that are close to zero duration, alongside short derivative positions.

However, not all managers agree with Eigen. These include Wesley Sparks, manager of the Schroder ISF Global High Yield and ISF US Dollar Bond funds, who argues that the market is right to disbelieve the Fed.

"Many believe that the Fed is overestimating both growth and inflation, which are still below historical levels. Meanwhile the bank's huge balance sheet is going to need lower rates; the drivers for an interest rate rise just do not seem to be there," he says.

Sparks concedes that the disagreement between the market and the Fed has "never been bigger". By the end of next year the Fed predicts that US interest rates will be at 1.4% while market pricing is anticipating 0.5%, with the gap growing larger over the longer term.

The manager is throwing his lot in with the market, arguing that the Fed has a "confidence bias towards growth" as bullish announcements tend to boost the economy.

On an instrument level Sparks is most confident in 30-year bonds - where he is significantly overweight compared to his benchmark - as like Eigen he does believe that when a rate rise comes it will do so suddenly, potentially hurting five to seven-year Treasuries the most.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.