After nearly four decades of declining interest rates and central bank policy rates hitting zero, the combination of quantitative easing policies, low inflation and tepid growth has driven sovereign bond rates to historic lows. The best case today is that rates remain stubbornly low, but investors face the risk that a new reliance on fiscal stimuli could create budget strains, and drive inflation and rates higher.
Sourcing income and managing potential income volatility in this new rate regime presents unprecedented challenges for both fixed-income and equity investors, particularly given that most have only lived through a period of declining rates.
After having the wind at their backs for decades, fixed-income investors are facing new potential headwinds. With bond yields still low, small rate changes result in large volatility, and a modest uptick in yields would produce negative returns. In such an environment, fixed-income investors need to consider that interest rates/duration is just one part of fixed-income investing; credit quality, currency exposure, and inflation present new opportunities and risks.
Equity investors who rely on dividends for income need to identify companies that can initiate and/or grow dividends and pay attention to factors that are harbingers of potential dividend reductions.