Kames Capital: Why rate rises will not cause fixed income liquidity to evaporate

The first rate hikes by central banks will not cause liquidity in fixed income markets to evaporate, and may actually improve trading conditions by removing uncertainty, Kames Capital’s Adrian Hull has said.
 
While there are concerns the first rate hike could impact bond markets by sparking a rush for the exit, Hull – Kames Capital’s fixed income product specialist – said a move to begin normalising interest rates may provide a boost to fixed income markets.
 
“Liquidity has worsened in the last three months, but while it is not going to return to anything like pre-crisis levels, a rate hike will not make it worse,” he said.
 
“On the contrary, there is an argument that rate rises in the US and UK may actually improve liquidity by removing the uncertainty that pervades markets.”
 
Safe havens such as US Treasuries and UK gilts have seen yields move sharply lower in the last three months as investors grow more concerned about the outlook for global growth.
 
Hull said growth concerns have pushed back rate rise expectations, although he still expects the US to hike rates at the turn of the year, with the UK following in the middle of 2016.
 
Until there is any policy action from central banks, Hull said most areas of fixed income outside of safe-haven government bonds looked vulnerable.
 
“Fixed income has a problem at the moment as few investors favour it. Some areas – such as high yield and emerging market debt – now look attractive on valuation grounds, but sentiment remains poor,” he said.
 
“When you combine that with the impact of outflows on the sector, it is not creating a great backdrop to increase your allocation to fixed income.”
 
However, Hull said when sentiment turns, a number of sectors looked primed to outperform, including financials.
 
“For us, financials look like one of the more compelling opportunities in the market if sentiment was to turn a corner,” he said.
 
“In particular, the bigger entities look attractive, so that is an area our teams might focus on.”