Bonds have continued to play their defensive role in portfolios amid sustained volatility in other investments.
In 2020, this role was made easier by the massive rally in yields that was underpinned by aggressive monetary easing across governments coupled with the pandemic induced flight to safety.
This year, however, portfolios may be subjected to a bumpy ride given the growing risk of higher yields, as economies recover and inflation expectations rise faster than initially expected.
Accordingly, markets are pricing in the possibility that central banks may have to begin normalizing monetary policy sooner than earlier guided.
Moreover, the impact of higher interest rates on equity valuation may also make for more fragile portfolio returns.
Closer home (Kenya), yields have also been gradually rising, a move that would traditionally shift investors tact from duration play.
However, the play has been rather atypical.
The government has stayed off the short end of the curve, in a strategic move to lengthen the maturity profile of public debt and reduce short term liquidity needs.
Consequently, the supply of short term papers in the secondary market has also thinned, reflecting this shift at source but also the need to hold onto these papers for liquidity purposes.
At the same time, a dearth of investment alternatives as well as the said risk aversion has left most investors with little option but to settle for the offered tenors.
Moreover, liquidity conditions have been fairly ample allowing banks more comfort to play the duration game.
Looking ahead, recovery prospects, which could raise credit demand by investors, coupled with the increased local borrowing from Treasury could sustain higher yield expectations, inviting further caution on the sensitive longer end.
Even then, considering the dearth of investment alternatives.
We still expect a considerable allocation of liquidity on bonds, tenor notwithstanding.
NCBA Research: research@ncbagroup.com
