2012 was another great year for fixed income assets. Although in contrast to 2011, when core government bond returns exceeded expectations, last year it was all about credit and emerging markets, as these sectors provided double digit returns. When the history books get written, the summer of 2012 will go down as a defining point in the recovery. The ECB announcing outright monetary transactions (OMT) and the Fed initiating “unlimited” quantitative easing (QE) will be seen as point when the major central banks moved from a re-active to a pro-active stance in dealing with the crisis. Their action calmed investors and gave them comfort that the tail risks that had been lingering in the back of people’s minds had been reduced, allowing risk assets to perform.
The action by central banks has been impressive, but by no means is the world fixed. Deleveraging and austerity in the developed markets will need to continue as we look to reverse the excesses built up prior to 2007. Monetary easing will be kept in place to offset the necessary fiscal adjustments and zero interest rate policy (ZIRP) will be around for longer than most people expect.
As we look forward into 2013 it is unlikely that the returns witnessed in 2012 will be repeated. Yields in credit and emerging markets have fallen to historical lows and the bond math will not allow last year’s capital appreciation to reoccur. However, in a world of near zero cash rates the demand for yield remains and exceptionally accommodative monetary policy continues to make fixed income assets look attractive on a comparable basis. In this stage of the cycle, as risk premiums have fallen, the easy trade is over and 2013 will be a year where sector and security selection is critical, as investors look to benefit from relative value and earn their carry.