By the Cross Asset and ETF Research Team at Lyxor Asset Management.

How to prepare your bond portfolio for the summer.

After the soggiest of summers so far, our thoughts are turning to the holidays and long, relaxing days by the pool. But before you go, remember to check the forecasts and ensure your investment portfolio also has the requisite protection in place. Like an unruly child, today’s markets and politics demand constant attention, however wearisome it may be. Here’s our guide to a successful and stress-free summer:

1. Be prepared for more bad weather

A sharp move lower in yields and the inversion of the US yield curve have raised concerns about a potential recession at some point in the next year. With the odds of a prolonged trade war increasing, global growth expectations have dropped dramatically over the past year. The market is now pricing three 25bp rate cuts for 2019 in the US, with the first rate cut in July. US bond yields should move even lower from here and favour short duration assets.

Source: Lyxor Asset Management.

2. Choose your destination wisely

There are some bright spots, however. Easier Fed and ECB policy sets will keep up the pressure and encourage markets to take on more duration and credit risk and to favour the higher yielders. We still see value in peripheral bonds, but it won’t necessarily be an easy ride. We’ll be watching out for any sign of more tension in Italy in particular. The biggest threat would be a very expansive budget for next year. We still favour Spanish bonds.

Source: Lyxor Asset Management.

3. Choose credit over sovereigns

We are still positive on the outlook for credit and high yield in particular. While the latter is cyclical, risk-adjusted returns remain appealing. Performance should also be underpinned by the dovish policy stance and low default rates.

Source: Lyxor Asset Management.

Consider something more exotic

With developed markets overcrowded and overvalued, it could be time to spread your wings to some more exotic destinations. We expect policy support from most EM central banks. Easier external funding conditions should give those countries with real currency sensitivity or heavy external debt burdens more breathing room. Subdued inflation pressure also offers ample scope for rate cuts. Hard currency bonds should benefit further.

Source: Lyxor Asset Management.

Beware Brexit tribulations

The change in prime minister and in government over the summer raises the risk of a hard Brexit substantially, whatever the position of Parliament. The election of a new leader looks unlikely to solve the Brexit impasse and may well lead to another extension of the deadline, which may cloud the UK economy’s outlook well beyond 31 October. Short-term rates are currently pricing in a BoE rate cut within the next 12 months. Gilts should remain supported in such an environment.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)