What rising bond yields will mean

Shane Oliver, head of investment strategy and chief economist, AMP Capital

Inflation is starting to stir globally and bond yields are also on the up. I expect the rise in bond yields to be relatively gradual but it is important to start thinking about what the implications may be for investors.

We can expect: Mediocre returns from sovereign bonds. Over the medium term, the return an investor will get from a bond will basically be driven by what the yield was when they invested. 10-year bond yields of 2.8% in Australia imply bond returns over the next decade of just 2.8% or so. And in the short term rising bond yields will mean capital losses.

Higher bond yields will impact sharemarket returns as they make shares more expensive. Shares will be OK if the rise in bond yields is gradual and so can be offset by rising earnings – as we expect this year – but a large, abrupt back-up in bond yields will be more of a concern. In any case, expect a more volatile ride in shares.

Defensive high-yield sectors of the sharemarket are likely to remain under pressure. This includes real estate investment trusts and utilities that benefited from falling bond yields.

When it comes to real assets such as unlisted commercial property and unlisted infrastructure, the search for yield is likely to remain a return driver unless bond yields rise aggressively. Heading into the GFC, it was only when bond yields rose above commercial property yields that commercial property prices started to struggle. We are a long way from that but as bond yields trend higher the valuation boost to commercial property and infrastructure returns will gradually fade.