The US Federal Reserve has acknowledged the risks to economic growth are on the downside and cut int...
The US Federal Reserve has acknowledged the risks to economic growth are on the downside and cut interest rates by 200bp so far this year. Further Fed easing is expected in the coming months.
The UK economy is not in nearly such a bad way. Growth for the final quarter of 2000 was revised up from 2.5% year on year to 2.6% year on year. The UK consumer remains buoyant and although the annual retail sales growth rate dipped from February's 5.8% peak slightly last month, it still stands at a high level.
Confidence is being boosted by a strong labour market and the number of jobless has fallen below one million for the first time since 1975. Meanwhile, inflation has risen only slightly, but at 1.9%, the underlying Retail Price Index measure is still well below the Bank of England's 2.5% target.
Minutes of the last MPC meeting showed the committee was unanimous in voting to cut rates, with three members even considering a 50bp cut. It appears that some members recognised that the committee's assumptions have led to a sustained undershooting of the inflation target. However, concerns over the strength of the domestic economy and the possibility of giving an extra boost to consumption stayed the committee's hand. We expect the Bank of England will want to see another couple of months' data before moving again.
In the Budget, the Chancellor accepted Paul Myners's recommendation to scrap the Minimum Funding Requirement (MFR) for UK pension funds. Changes to the MFR have been widely anticipated for some time and the ultra long end of the gilt curve has disinverted as pension funds have been moving out of low yielding gilts into higher yielding non-government bonds, particularly long-dated AAA-rated names.
What about corporate bonds? From the second quarter of 1999 we saw the share prices of old economy corporates trading sideways while the new economy boomed.
Old economy corporates came under increasing pressure to enhance shareholder value through share buy-backs, and depressed equity prices raised the likelihood of takeover activity. None of these factors were positive for corporate bond spreads, which widened in anticipation of slowing activity and fears of bondholder unfriendly actions.
Corporate bonds offer investors the opportunity of attractive yield enhancement over gilts. Corporates have also benefited as lack of supply and strong demand have underpinned the market.
If there is a severe downturn, corporate bond yield spreads over governments would probably widen further despite last year's action.
However, we are not forecasting a deep, prolonged downturn and expect corporate bonds to perform well when there is more supportive economic data.
Kevin Adams is director of UK Fixed Income at Credit Suisse Asset Management
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