Despite recent signs of a moderation in US growth, we believe that it is premature to conclude that ...
Despite recent signs of a moderation in US growth, we believe that it is premature to conclude that interest rates are beginning to bite. Growth in the US and continental Europe is forecast to continue to run ahead of trend and in this environment, additional monetary tightening continues to be expected in both markets.
On the face of it, this is bad news for global bonds. However, we are also mindful that inflationary pressures continue to remain subdued and with real yields high on a historic comparison, this should lend fundamental support to bond markets and provide something of an anchor for long dated bond yields. Indeed one could even argue that with growth set to slow in 2001, then headlines focusing on the spectre of deflation may not be all that far away.
In terms of current strategy, this means duration is held only slightly short of index. However, a stronger view is expressed with respect to yield curve strategy. We maintain a barbell position in both the US and euro markets where we expect yield curves to continue to invert as short rates rise just as long dated yields remain stable.
Few strong views between bond markets are currently expressed. Japan remains our least favoured region given our long held fears that the mounting debt burden fuelled by ongoing fiscal deficits will one day come home to roost.
However, in the near term we view an early end to the 0% interest rate policy pursued by the BoJ as unlikely and therefore maintain only a small relative underweight position.
In currencies we believe the euro will continue to rally. Growth rate differentials are set to narrow between Europe and the US and with the US current account looming in the background, we believe that the euro will recover from previously over-sold levels.
We are also excited by prospects for 'crossover' markets; that is to say former emerging markets which have graduated into the investment grade universe. Specifically we are optimistic on Polish bonds where yields are very high (18%) and where economic fundamentals are strong. Further credit upgrades are expected over time.
We also see value in corporate bonds. Spreads have widened to unprecedented levels, which is particularly surprising when one considers a backdrop of robust economic growth. Although the falling supply of government bonds is likely to mean that corporate bonds continue to trade cheap to their long run fair value, we believe there are now interesting opportunities which we can seek to exploit.
Mark Dowding is head of global bonds at INVESCO Asset Management
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