Intensification of violence in the Middle East and heightened stock market volatility have led many ...
Intensification of violence in the Middle East and heightened stock market volatility have led many investors towards the relative safety of the bond markets over recent weeks. Meanwhile, softer global economic data has also continued to boost returns from bonds. However, the outlook for bonds is more mixed, especially as equity markets regain their poise.
In the US we expect the economy to stabilise at its present below-trend level of growth and we do not expect any further hikes in US interest rates during the current cycle. This should provide good support for the US bond market. Inflationary pressures remain, however, and it may be some time before the Fed is confident enough to loosen monetary policy.
In this case, Treasuries look over optimistically valued at current levels. The positive effect of the improved US fiscal situation on long-dated Treasuries is starting to wane, and this may cause the yield curve to further dis-invert.
In the UK, we expect the publication of the Myner's Report on pension fund liabilities to cause long-dated gilts to underperform.
The report was expected to expand the range of eligible assets for pension funding requirements, in place of the present sole reliance on long-dated gilts. The slowing UK economy should continue to support the rest of the market.
However, we expect the Bank of England to remain vigilant against the inflationary effect of sterling's recent weakness against the US dollar, and the rising price of fuel. Therefore, a further tightening in monetary policy cannot be ruled out.
Similarly, eurozone inflation is also showing upward tendencies. Unlike the UK, though, the risk of inflation is much higher in the eurozone because of the combination of currency weakness with above trend economic growth.
Although growth has showed signs of slowing, the upward cycle for euro-zone interest rates may still have some way to go. This will inevitably bring higher bond yields at the short end of the curve.
The outlook is also difficult for Japanese bonds. This is because, although the rate of supply of JGB's has slowed, signs that Japanese economic growth is accelerating are likely to be bad for investor sentiment.
We do not expect to see a significant deterioration in yields at this stage because the economy still has considerable room to expand before inflation becomes a serious threat, especially while consumer demand remains weak.
Our global bond preferences remain in favour of US Treasuries. The positive effect of slowing economic growth and the potential of earlier than expected interest rate cuts, however, now appears to have been priced into the market. Therefore we are looking at trimming back this position.
Guy Dunham is fund manager of the Save & Prosper International Bond Fund
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