068 | How economies impact on the bond market

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  • Nick Hayes, Head of Sterling Rates and Credit, AXA Investment Managers

Learning outcomes:

  1. The economic cycle and how it impacts on bond markets
  2. How global bond markets have expanded over the last 20 years and the implications of this growth.
  3. The role central banks can play to improve or hamper the outlook for bond markets


Learning outcomes: 1. The economic cycle and how it impacts on bond markets. 2. How global bond markets have expanded over the last 20 years and the implications of this growth. 3. The role central banks can play to improve or hamper the outlook for bond markets. Tutor: Nick Hayes, Head of Sterling Rates and Credit at AXA Investment Managers PRESENTER: Hello and welcome to this Akademia learning unit with me Mark Colegate. Today, we’re looking at how economies impact on the bond market, and to discuss that I’m joined by Nick Hayes. He’s Head of Sterling Rates and Credit at AXA Investment Managers. Well, Nick, the economies and the bond markets, how interlinked are they? NICK HAYES: Very interlinked. I think fixed income more than most asset classes, maybe equities for example, is very much driven by what’s happening in the economics. The sort of top-down environment is a big driver of where fixed income markets go. Things like interest rate policy are very important to government bonds. I think the key is that in fixed income you have many different markets within fixed income. So you have government bonds, you have inflation-linked government bonds, you have investment grade, high yield and emerging markets, and they’re all slightly driven by different factors. But certainly the economics is a big driver of different parts of fixed income and the kind of returns you can get. PRESENTER: And is it the economy that tends to drive what happens to bond markets, or is it the bond markets that tend to drive the economy? NICK HAYES: I guess you could argue a little bit of both. But essentially when you’re looking at fixed income markets and investing in different parts of the fixed income market, you’re always looking at what the background economics is, where GDP is, where, your expectations of where interest rates are and going to be. I guess the big difference is the timing effect. There are times when the bond market is pricing in more or less interest rates that you either agree with or don’t agree with, and sometimes interest rate policy is slightly ahead of where the bond market is. So there is a two-way relationship: certainly there is a big impact of economics and central bank policy that drives what happens to bond markets. PRESENTER: And one thing we always hear fund managers talk about is the economic cycle, what is it and how important is it as a way of thinking about the bond markets? NICK HAYES: It’s very important, I guess. An economic cycle is the kind of fluctuations between going from a good economy to a bad economy, or strong GDP to weak GDP, or vice versa. So you look at things like interest rate policy, GDP, inflation, and you see the kind of fluctuations from strong market to weak market. And I guess there’s no specific time that people talk about being at a cycle, but to go from a sort of strong economy to a weak economy and back up to a strong economy, that would be typically an economic cycle. And within that you’ve got different interest rate policies. So when the economy is strong you have higher interest rates, as it starts to weaken off in order to create inflation or stronger growth central bank policy will decrease interest rates, and all the time that is having a big impact on different parts of the fixed income market. PRESENTER: Now you mentioned a little earlier there’s obviously lots of different parts of the bond market; how do these major components of the bond market react at different points in the economic cycle? NICK HAYES: So, if you break down fixed income into government bonds, investment grade credit and high yield credit, that covers three very broad parts of the market. Government bonds is the debt issued by governments; that invariably in good quality governments or developed market, it doesn’t have any credit risk so there’s not a risk, well not a significant risk of default from something like the UK or the US government. But what you have is a risk that interest rate policy will change. So if interest rates go up that’s bad for government bonds, and if interest rates go down that’s good for government bonds. So interest rates would be a big driver of the returns and the yield levels that you can get on government bonds. And then the further down the credit curve you go, so when you start investing in investment grade debt, so good quality debt issued by companies, you would start to invest in a credit spread. So the additional yield you can get over and above government bond, which is essentially credit risk. If I’m investing or lending to good quality companies there is clearly an increased chance that they might default on their debt. So as an investor I would require a yield premium or an increase in yield over and above what I’d be getting in the similar maturity from a government bond. And then finally once you go into high yield companies, which is sub-investment grade or BB and the worse-rated companies, clearly they tend to be much more risky companies, and for that extra risk of default I would require a higher level of yield or a higher level of spread. So again if you think about government bonds, investment grade or high yield, by going down that credit curve, so by taking more credit risk and less purely interest rate sensitive risk, you’re changing the dynamics of what you’re investing in. So you’re investing more in credit risk rather than pure interest rate sensitive assets. PRESENTER: Now you were saying a little earlier that higher interest rates rule of thumb are bad news for government bonds. Why? NICK HAYES: Ultimately it becomes a risk reward. If I can get let’s say a 5% yield in government bonds when interest rates are 2%, you’re taking maturity risk in government bonds, and you’re getting a higher yield for that. When suddenly interest rates go up, let’s say interest rates went up to 5%, I can put my money in a bank and get 5%, or I can take some sort of maturity risk in a government bond. It wouldn’t be still 5% because you’re clearly taking more risk or a different type of risk. So as interest rates go up that’s bad for government bonds, so the yield drops, sorry the price drops and the yield will go up to compensate for the alternative risk of having your money just in a bank account. PRESENTER: And when interest rates are going up what, you mentioned there about the credit spreads, let’s talk about investment grade credit. Is that good news or bad news for investment grade credit? NICK HAYES: It should be good news, because essentially the reason interest rates would be going up is because you might have some gentle inflation coming into the economy. You might have positive growth. So the economy is generally in a positive environment. You have more employment. You have companies creating better profits. So that generally, while that’s bad for government bonds because interest rates are going up, so that’s bad for your government bonds, it would be good for investment grade credit, would be good for companies. Because companies would be benefiting from the stronger economy, they’d be making more profits. They would possibly be expanding and growing their businesses. So if it’s bad for government bonds it should be good for credit bonds. And the yield on the spreads on credit bonds should be tightening. PRESENTER: Now one thing we have seen in the last couple of decades is this incredible globalisation in markets, not just bonds, equities, the whole lot: much more complexity and choice coming through. How’s that affecting developed bond markets, particularly the UK where most UK investors will start out from? NICK HAYES: I think it’s certainly widening the investment remit. You go back maybe 10, 15, even 20 years, I’ve talked about government bonds, investment grade, high yield, your universe would have been much smaller, so the European high yield market was only really created 10, 15 years ago. As we fast forward to the 21st century you’ve suddenly got access to much more emerging market debt. You’ve got exposure to much broader number of companies in European high yield for example. So certainly globalisation has meant that you have a wider investment set, and there are more companies and more countries have issued debt over the last number of years, which has come to play. And I think also as global investment markets have grown it means you can buy emerging market debt funds or different areas of expertise looking at very different types of markets, debt markets. PRESENTER: But if you’re investing in developed market bonds, say the UK today, how is things like this rise of the emerging markets and China affecting the way that the prices move, the supply and demand? NICK HAYES: I guess two things spring to mind. First of all is that global economics has become much more important to us. If you look at central bank speeches or from central bank speeches from the Fed you can suddenly see that the number of times they mention things like global or China has increased over a number of years. So certainly the global economics impact has affected it. And suddenly when Chinese growth starts to weaken, then suddenly that has big implications for developed markets, so the US, UK and European, and vice versa, so there’s much more, a much stronger link between the global economics. And then certainly on an asset price basis it becomes much more common now to look at flows from different asset classes and different parts of the asset class. So you might see for example if lots of investors are selling out of US government bond funds, they might at the same time be buying lots of emerging market debt funds. So you see a flow from interest rate sensitive assets into credit assets, and those credit assets might be into developed market, investment grade developed market, high yield, or indeed emerging market credit. So you suddenly see the flow of capital becoming, has a much more wider investment set, and there’s lots of different opportunities for investors to move their capital from different parts of the fixed income market, and outside of the fixed income market as well. PRESENTER: So is the power that the Bank of England has over say British, the British bond market, is that declining as a result of this globalisation? NICK HAYES: Yes, I think it still has a very influential level, and if you’re investing in sterling-based assets clearly what is happening to sterling, the currency, or Bank of England central bank policy is absolutely key. But clearly with the globalisation suddenly you have to look at external factors such as what’s happening in the US and what’s happening in other European or emerging markets. So I guess as a direct influence it’s still very strong, but there are other external factors that are becoming increasingly important. PRESENTER: Now you mentioned government bonds, investment grade and high yield bonds in the developed markets. Does the same story apply once you get out into emerging markets or is it a little bit more complex than that? NICK HAYES: It’s a little bit more complex but I think you could draw a similar analogy. Within the emerging market space you have high quality sovereigns, so high quality governments, and you have high yielding or lower quality, lower rated emerging market issuance. You have the same in the corporate space. So in companies or credit you have good quality investment grade, but you also have lower rated high yield paper. The other area of complexity for the emerging markets is they can issue in different currencies. So you can either issue in what is known as hard currency, which is US dollar-based assets. And it might be preferential for an emerging market country or company to issue in dollar-based asset. Alternatively they might be investing in their own local currency, which obviously you have a big FX element if you’re investing, if you’re lending to whether it be China or Venezuela and you’re investing in the local currency, you have a big FX element which is a big impact. PRESENTER: And how much control have these countries in emerging markets got over how strong or weak their currency is? NICK HAYES: It all comes back to their local economics and their central bank, and their ability to move up or down their interest rates, and that invariably will be a driver of what’s happened to their currency. Because if you have high interest rates that might create demand for a currency because of the high base rate. Or conversely if you have a much lower interest rate that might weaken the currency. So certainly the interest rate, central bank policy, the interest rates and the FX are very strongly linked, and that ultimately creates positive or negative capital flows where investors look to be attracted by the high yield, or else flee because they’re concerned by the underlying weak economics. PRESENTER: Now we’ve been talking about all these different types of economies that are out there, but can you give us an example of a good, a virtuous economy that’s positive for bond markets? NICK HAYES: Well I guess if we think back to 2005, 2006, 2007, where you had a strong developed market economy, you had interest rates gently going up, which was bad for government bonds but it was good for credit. It was good for companies, it created lots of demand for credit, and you saw that investment grade debt and high yield debt, yields were coming lower as you saw demand out of government bonds into credit quality whether it be investment grade or high yield in say Germany for example, or France or the UK. So that period from 2003/04 up until 2007/08 was a gentle positive economy that had slightly rising interest rates, but it had much strong benefit to credit and investment grade and high yield spreads. PRESENTER: But others would say well actually underlying all of that it was being built up on some fairly dodgy economics. It looked good in the short term. NICK HAYES: It was strong economics but it was a credit-fuelled economy. It was an underlying economy that was strong because of the ease of which you could leverage yourself up or borrow money. So certainly the underlying economics and the banking system was allowing the economy to grow by having a weak control over the amount of leverage in the system, and that clearly created its own issue, which I guess we’re going to come on and talk about. PRESENTER: So really your point is it’s important to make a distinction between the strength of the economy and perhaps the size of the borrowing or the credit market that’s attached. NICK HAYES: Yes, so you have, fundamentally if the economy is strong that means higher interest rates. It means that that should be bad for government bonds but good for investment grade and high yield companies. If you think about investment grade and high yield as being correlated or linked towards the equity markets in a strong economy, a good economy, it should be good for equities. And likewise that is good for credit markets and specifically the further down the credit curve you go, so high yield and investment grade. PRESENTER: And one thing we’re always hearing about is how much the government spends. I mean it’s in the news all the time. As a rule of thumb is a government that borrows very little or is paying debt down, is that a good thing for bond markets? NICK HAYES: There’s not an absolute level that you can point at and say that is a good or a bad level. It comes down to finances and no different to personal finances. There’s a point at which it is efficient for me as an individual to borrow a certain amount of money. There is a point at which I’ve borrowed way too much money and I become a big credit risk. So the bank is very keen to lend me money to a certain point, and at some point if I’m borrowing too much money, or if I’m borrowing against my house and my house value has dropped, then that clearly becomes very risky. It’s exactly the same principle for a government. It is clearly efficient for a government to borrow a certain amount of money. Borrowing no money would be very inefficient, because you need to create capital in order to reinvest in health systems and pensions and the like. But at some point borrowing too much money takes you into the more riskier-type country, and therefore the price of that debt rises, and your ability to finance that becomes much harder. So there have been lots of studies over the last couple of decades on the optimal number of debt to GDP. People think about 70-80% of debt to GDP in developed market world as being quite an attractive level. There’s plenty of studies that suggest once you go higher than 80% of debt to GDP the country becomes quite risky, and therefore the markets take fright and they demand much greater yield if you’re to lend to the country. PRESENTER: So having trust in the central bank policy, and trust in the government, and by that I mean the government long term, are core fundamentals of a virtuous. NICK HAYES: And it comes back to this concept of when you’re in, when you’re borrowing money as an individual, a company or a country, having the trust of your underlying lenders is usually important. So say if you have a stable government, if you have a government that continually delivers on policy, that doesn’t create too many positive or negative surprises, that generally instils a lot of confidence, and it means the level of which you can borrow should be relatively stable. Once you start to deviate away from those plans and you lose faith, or the investors in your debt lose faith, then clearly that creates volatility and no one likes uncertainty in debt markets. PRESENTER: Well we’ve talked about the good economy, but can you give us an example of a bad economy? NICK HAYES: I guess if I think about global fixed income markets, Argentina would be a good example of a bad economy, whereby they’ve defaulted on their own debt. It feels like every 10 years or so, but certainly for the last couple of decades they have defaulted on their debt. And that would be an example of a country that would have had good economic times. It would have borrowed lots of money. But instead of creating a fairly steady state, continual reinvestment, they might have done something irresponsible or done something, borrowed too much and therefore once the faith of investors tips over suddenly the yield goes much higher. Suddenly they haven’t, maybe the economy starts to take a downturn, and then they have an inability to refinance their debt. PRESENTER: And when something like that happens, for how many years does it affect the way the markets look at the country? And therefore does it affect the price at which that economy can borrow money, and I guess recover in the future? NICK HAYES: I mean I think you could argue it always affects, people have a pretty long memory. But again there’s a tipping point at which, there is a price for everything. And at some point when the yields go very high, a single country’s ability to refinance themselves becomes impossible, so they have to go through a debt restructure or a default on their own debt. Once they do that they then are put the handcuffs on by the debt restructurers. They go through a number of invariably years of austerity. They get their finances back in place, and then slowly but surely most countries or companies or individuals can go back to the debt markets and borrow at a sensible level. Invariably that’s again a tipping point between being attractive enough that it invites investors back in, without being too expensive that it would be impossible for them to refinance that. So there is a tipping point, and then as confidence grows and time goes on you tend to see the yield come lower and lower, and their ability to refinance themselves becomes easier and easier. But again the cycle comes back where if the debt is too cheap or their ability to borrow is too easy, then you possibly have an irresponsible government come in, borrow too much and you start on the same cycle again. PRESENTER: And what if the government said well we’re definitely going to pay you all back, but we’ve got quite a lot of inflation. That’s a great way of eroding the real value of the payments we have to make to you. Is that a policy that many follow, how do the bond markets react? NICK HAYES: Sometimes inflation is bad for bonds generally because inflation creates, in order to control inflation you need higher interest rates. And as we talked earlier higher interest rates is bad for bonds. So essentially some governments will allow inflation to get much higher and reduce their debt pile. But what that would do, that would frighten fixed income investors, and it would drive them away from the fixed income assets. You’ll have more sellers than buyers, clearly your price is going down and your yield is going up. And again the key with fixed income is your ability to refinance. Every time you borrow you’re borrowing for a certain amount of time. When you get to that, end of that period when your bond matures, unless you can repay the entire amount of your debt, which is not generally business models, you need to refinance in order to pay for the rollover of that effect. And if the price of that is too high it becomes very difficult to refinance. PRESENTER: Now we’ve talked a bit about what the effect of inflation is on bond holders and investors in bonds, but what’s the effect of inflation when that actually gets into an economy? What impact does that have on goods, services? NICK HAYES: Destabilising economy, suddenly if inflation is too high you have the prices of goods going much higher. If you don’t have wage inflation to keep up with that, again as an individual you’re suddenly having to buy things for much higher prices, but you’re not getting the required level of same inflation on your income. So high inflation is generally very bad; it’s particularly bad if the income levels are not keeping up with the higher cost of goods and services. PRESENTER: Now on this spectrum between a good and a bad economy, where does the UK sit? NICK HAYES: Pretty good, I mean if you think about rating agencies you have triple A at the very highest level, AA, A, BBB which is generally the investment grade space. The UK sits at the AA, AAA level, so it’s pretty much as good as you can get. And it would be, certainly being part of the developed market and having a very stable government and central bank policy, it would be deemed as, in terms of credit risk at the better end of the spectrum. PRESENTER: But the British have historically had a reputation for having a problem with inflation, is that all behind us now or are there peculiarities of the British economy compared to the French and the German that mark us out? NICK HAYES: Certainly as a bond investor I would never say that inflation is behind us, because you never know what’s coming next. But certainly if you compare our levels of inflation with other countries or certainly some of the emerging market countries, we have much more of a controlled inflation. And we have had periods where we’ve had single digit inflation, for the last couple of decades it has been low single digits, and more recently it’s very low. So again we need, central bank has a policy of creating inflation levels that are in and around 2%. We’re probably dipping below that at the moment. It’s in their interests and in the interests of the economy to target a higher level of inflation, which they’re trying to do at the moment. But essentially if you think of single digit inflation as being controllable and desirable, then the UK has a pretty good track record of doing that. PRESENTER: Do we really control it given it’s down to things like goods manufactured in China that are imported here? I mean how much control have we got over it? NICK HAYES: We have a certain amount of direct impact that you can control via the use of interest rates, via the use of goods and services. But also there are clearly imported, you mentioned services and goods from China for example, and also the commodity space. For the last couple of years we’ve seen a big fall in commodity prices, which has meant there is a deflationary impact. The price of you and I filling up our petrol tank has become cheaper. And that has a good impact for me as a consumer, but clearly it has a deflationary impact on prices and goods. PRESENTER: You were saying earlier what the ratio of GDP growth to debt was, and what looked attractive at a government level. Any equivalent figure for how much households should, what's an efficient level of debt for a household, and what’s getting yourself too far out? Is there a study on that anywhere? NICK HAYES: Not really, I mean if you think about bank lending I guess you could think of typically we’ve come down a lot over the last five or ten years as to what typically a bank would lend an individual to mortgage his house. Pre-crisis 2005, 2006, 2007, that clearly got too high as you heard about people being able to borrow on self-certificate, self-cert mortgages where they were signing off their own level of income. So that was irresponsible lending or aggressive lending. We’ve now gone the other way where you’re allowed to borrow three, four, five times your salary in order to finance a mortgage. PRESENTER: Now I want to move on, we talked about this growth of the debt markets over the years, but what has this meant for the financial system upon which we all depend? I guess particularly in light of what we’ve seen since 2007/2008. NICK HAYES: I think one of the biggest developments, we saw a big boom in underlying economies, we saw a big boom in debt issuance, then we had a very difficult economic period in 2007 to 2009, and I think that the biggest influence we’ve seen in bond markets is the introduction of new central bank policy. So traditionally you would think of in that economic cycle interest rate policy as being the main driver of central banks’ ability to control the underlying level of growth or inflation. Once we got to a level in 2008 or 2009 when interest rates got to pretty much zero, you then as central bankers started to think about different ways that they could try and stimulate growth in the economy. And the biggest introduction in any of our lifetimes has been the introduction of QE or quantitative easing. So you’ve seen central banks printing money in order to buy assets to bring yield lower in government bonds for example. And the theory being that if yields are so low in government bonds, then maybe investors such as ourselves, instead of buying government bonds we might be tempted to buy credit bonds. And if I’m buying credit bonds that brings the price of credit bonds down, which means maybe as a company what they should do is issue more debt because it’s cheap to borrow debt. And that might fuel some sort of better economy and underlying. So certainly in the last seven or eight years one of the biggest changes I think to us in bond markets is the introduction of different types of central bank policy, which is still going on in 2016. PRESENTER: And that QE, has the economic effects been what central banks wanted, have we all taken more risk, have we used that money wisely? NICK HAYES: There’s a couple of ways you can think of it. You can think of it as whether as central bankers they thought that one round of QE, one round of issuing finances in order to buy certain types of debt assets would be sufficiently successful that means you would need no more. So yields drop, risk appetite returns and the underlying growth improves. I think it’s fair to say seven or eight years on that hasn’t happened, and we have QE1, QE2, QE3. You’ve had QE from the Fed, you’ve had QE from the Bank of England, we’ve just announced QE from European Central Bank. So you can certainly argue one round of QE hasn’t been sufficient. So from that respect you could possibly argue that it hasn’t worked. Now if you think alternatively what would have happened if we didn’t have QE? What would have happened if the central banks hadn’t stepped in and promised or given an unwritten rule that they were going to try and keep yields very low in order to stimulate the economy? I mean confidence was so low in 2008 or 2009 that maybe confidence would have got even worse, and you might have had more Lehmans’ type events where you had more large investment banks or other types of institutions going to the wall. And that might have had a deteriorating impact on our confidence in the underlying system. So from that respect you could argue that QE has been successful, and that it’s stopped the ever decreasing circle of confidence that we felt in 2007, 2008 and 2009. PRESENTER: Has there ever been an event like this in the past in history that we can draw conclusions from? NICK HAYES: Not in our recent history no. Certainly if you look at a lot of the central bank policy, and you look at some of the new schemes that have been put into place, we’re certainly breaking new territory in a lot of areas. PRESENTER: At what point does all this money have to be paid back, or all these new printed pound notes be taken off the table? NICK HAYES: I think again if you go back six or seven years there was a view that they could print money, buy bonds, and then as and when confidence was re-grown they could recycle that money or sell their bonds back into the market, and we could move on from QE. Seven, eight, nine years after the event it looks increasingly likely that’s not possible. So I think the programmes are too large that actually I’m not sure I can envisage a bond market that can take back the assets that have been bought by the central banks. That’s not necessarily a problem, because if you’re a central bank you’ve bought these assets, you know that the underlying credit risk is the governments that you bought it in, so you’re not worried about that. So you can actually hold these bonds to maturity. So essentially you’re just buying debt and allowing them to sit on your own balance sheet, and then they’ll roll off eventually over time. But as I say it comes back to what were the central banks’ expectations in 2008 and 2009 for what QE would do? I’m not sure many would have been brave enough to say I think we’ll go on a Q, we’ll go on a bond buying programme and be buying assets that will sit on our balance sheet for multi decades, and they’ll just roll off slowly but surely. PRESENTER: And what is the impact of all this on, I mean we talked a lot about this impact on bond investors, but what’s the likely impact on equity investors, because they’re obviously investing in companies that are reliant on the underlying economies as well? NICK HAYES: So if you have companies that are issuing more debt, and you’re issuing debt that is cheap to companies as a borrower, then I think that can be a positive impact for equity investors. If you think back to theory behind QE, what should happen is that normally when I might be buying government bonds that yield 4-5%, suddenly the yields are being crushed to 1% or 2%. So I would say that no longer looks like an attractive investment, maybe I’ll buy investment grade debt. So instead of getting 5% in government bonds I might get 5% in investment grade debt. The more that we buy investment grade the yields come lower and lower, and suddenly that debt might price at 2 or 3%. If I’m an issuing company whereas normally I could borrow money at 5-6%, suddenly I can borrow money at 2% or 3%, theoretically I should be saying well why don’t I borrow a little bit more and then buy one of my competitors? Then I can get the synergies of combining two companies. I can borrow quite cheaply, so I can finance that quite cheaply in the debt market. And that should have a positive impact on the equity market because you’ve gone through a bit of M&A: you’ve had two companies coming together, that should create better growth, and the equity market should benefit. That’s the theory. The reality is that the confidence hasn’t always been there over the last number of years that maybe chief execs are more interested in reducing their debt pile, regaining confidence of debt investors, rather than offsetting the confidence of debt investors by having, by gaining higher share price and gaining confidence of equity investors. But we’re at a point, and certainly if you look at the US at the moment, there is probably, they’re probably a number of years ahead of where we are in Europe in that they are interested in that releveraging. They’re interested in borrowing a little bit more, being a bit more equity friendly, making sure that the share prices are rising and that is beneficial for the underlying equity holders, less so for debt investors. But if you think of where we are in Europe where we have still the threat of deflation, very low growth, we’re probably still in an environment where European chief executives are interested in deleveraging, so decreasing the debt pile of their balance sheet. Whereas in the US they’re slightly improved, again coming back to this economic cycle, they’re further along the economic cycle. The underlying economy is stronger, therefore they have more confidence to possibly try and grow as companies, which as I say is good for equity investors, less good for debt investors. PRESENTER: And where’s Asia/the emerging markets on that economic cycle that you’ve been describing? NICK HAYES: On a sort of, at the other end of the spectrum from where the US is. If you think of Europe as zero growth, very low interest rates, low growth. PRESENTER: So at the bottom of the cycle. NICK HAYES: Bottom of the cycle, the US is starting to improve and you’re starting to see improved growth. We’ve even had an interest rate rise, which we haven’t seen for a number of years. PRESENTER: Takes us back. NICK HAYES: Exactly, and China and the rest of the emerging markets are probably slightly on a decelerating phase. So there certainly feels like there is a shift of power at the moment away from emerging markets, which has been the strong area of growth over the last five or seven years. But as they’re rolling over and slightly deteriorating, the US is taking up the slack. PRESENTER: So despite all of this globalisation we don’t have a single global economy, we have regional economies that are vaguely synched but not completely. NICK HAYES: Definitely there’s correlations, there’s negative correlations, but you ultimately have one global economy that is made up of lots of small and some very large blocks, and that’s the biggest driver to thinking about the global economy, it’s thinking about the individual building blocks and the stronger groups. PRESENTER: Well, in summary, because we’ve got through a lot here, Nick, why should investors be keeping an eye on the state of the global economy and the bond markets, whatever asset class they’re investing in? NICK HAYES: So economics will drive all fixed income markets, whether it’s interest rate policy or whether it’s that a stronger economy is good for credit as opposed to government bonds. So there is a strong correlation with what is happening in the underlying economics, and what is happening in the different parts of the fixed income market. That is rule number one. Secondly is that within fixed income you have many different sub-asset classes. So you have government bonds, you have inflation linked government bonds, which will benefit from a positive inflation environment. Whereas government bonds typically won’t do well in an inflationary environment. You have good quality credit spread, which is investment grade, so you should benefit more from an improving underlying economy. Then you have high yield companies which will, their performance is much stronger correlated or linked to what’s happening in the equity market. If equities do well high yield company debt will do well. PRESENTER: We have to leave it there. Nick Hayes, thank you. NICK HAYES: Thank you. PRESENTER: In order to consider the viewing of this video as structured learning, you must complete the reflective statement to demonstrate what you’ve learned and its relevance to you. By the end of this session you will be able to understand and describe the economic cycle and how it impacts on different parts of the bond market; how global bond markets have expanded over the last 20 years, and the implications of this for economic growth; and the role central banks can play to improve or hamper the outlook for bond markets. Please complete the reflective statement to validate your CPD.