Old Mutual is increasing its weighting in bonds in its global portfolios as fiscal discipline has im...
Old Mutual is increasing its weighting in bonds in its global portfolios as fiscal discipline has improved among western governments. This is going along with inflation being well contained, generally, not only at the level of final prices but also in terms of wages and raw material costs. Even oil prices are easing back as Saudi Arabia raises production. The outlook for bond investors is good.
Ten years ago, the "twin deficits" had become a staple of US economic and political commentators. Two Republican presidents had allowed the budget deficit to grow hugely by the end of Bush's term. A similarly huge trade deficit was linked to that easy fiscal policy, so a weak dollar was expected to persist along with high bond yields. At the same time, Japan was running a budget surplus and huge trade surpluses. Low Japanese interest rates and a strong yen seemed the reward for virtue.
Over the past decade, the position has been transformed. Few, if any, expected the Democrat president to reduce the budget deficit and then to go on to make surplus-financing a central feature of his second term in office. This has gone along with economic activity growing rapidly, year after year, while inflation has remained low.
Many Western countries have followed the US example but Japan has taken the opposite course. Faced with a prolonged recession after the bubble of the late 1980s, Japanese governments have launched a sequence of bigger spending programmes. These have created budget deficits which have grown to 10% and more of GDP in the past two years, without reviving the domestic economy, yet.
Saudi Arabia is now raising oil production, so oil prices are likely to keep falling back from their peaks. Though the benefit may not be felt at the pumps over the summer, oil price inflation is likely to disappear rapidly over the balance of the year. This will keep inflation well controlled more generally, notably by keeping wage inflation modest and improving the trade balances of oil importing countries.
Investors need to come to terms with the new landscape created by these trends. The supply of government bonds is shrinking in the US and the West more generally. The policy consensus has shifted so much that budget surplus now seems likely to be continued for many years, making government bonds increasingly rare and expensive. That is good news for existing holders, but implies they will need to look more widely for future investments and become more willing to take corporate and emerging market bonds into their portfolios.
Meanwhile, international investors are likely to become increasingly nervous of holding the rapidly growing stock of Japanese government debt. So far, the authorities there have been able to place it while keeping the yield comfortably below 2%.
It shocks you
2,000 people surveyed
Six FTSE 100 female CEOs earning 32% less than men
It is the 'Second City'