The takeaway for fixed income investors is equally nuanced. If the basic recovery story remains intact, we can expect longer-dated bond yields to creep up, at least in the UK and the US, causing losses for holders. Economic fundamentals will be important here, too, because policymakers in both countries have made clear the timing of official rate rises will continue to be ‘data dependent’.
If the US and UK recoveries remain on track, the likely divergence in policy between the US and the eurozone suggests some opportunities for fixed income investors to protect returns by diversifying their holdings.
Within fixed income, investors can also broaden the mix to include high yield bonds and other assets capable of showing positive returns in a rising rate environment.
But investors should remember that the world is still a very long way from normal. By my calculation, output in the developed world is more than 9 per cent lower than it would be had countries simply continued on their long-term trend after 2007. We know the global economy is getting better. The key concern for policymakers is whether it can grow fast enough to make a serious dent on that lost output.
Whether it’s the likely path of interest rates, the risk of inflation, or the long-term return on developed market equities going forward, the answer to many of the questions central banks are facing will depend – in no small measure – on how much of that lost capacity the world gets back.
What investors should be asking themselves in 2014 and 2015 is not whether we have a global economic recovery, but by how much it is going to recover.
Stephanie Flanders is chief market strategist for the UK and Europe at JPMorgan Asset Management
