Bond returns will be boosted by a predicted downturn in the strength of sterling against the euro, a...
Bond returns will be boosted by a predicted downturn in the strength of sterling against the euro, according to Baring Asset Management.
Andrew Cole, director of Barings strategic policy group, said the improving currency position gives him cause for optimism. He predicted it will contribute to US 10-year bonds returning 7.3% in sterling terms. The UK equivalent will return 7.1% with European bonds returning 19% and Japanese 12%.
He is similarly positive about 30-year bonds and expects the US to return 7%, the UK some 6.6%, Europe around 16.4% and Japan some 11.2%. In the three-year bond sector he expects US bonds to return 7%, the UK some 6.6%, Europe about 16.4% and Japan some 11.2%.
Cole said he expected GDP growth to end the year at 3.1% compared to a consensus of 3.2%, with underlying inflation edging up to 2.5% against the consensus of 2.0%. The current account deficit will end the year at £18bn compared to expectations of £18bn.
Cole said the improving fiscal climate is increasing the importance of investment grade corporate bonds to investors looking for income. He added that according to Barings' fair value models corporate bonds looked attractively priced.
Cole said: "If you look at the Salomon's Global Bond Index in sterling terms we would expect to see returns of 13%.
"Euroland bonds in local currency we expect to return 6.5% over the next 12 months, and we would expect a recovery of about 11% in the euro against sterling."
Higher returns will come as a relief for income investors after a very poor 1999 during which bonds from the UK, Sweden, Denmark, Germany, Holland, Italy, Spain and France all produced negative returns in sterling terms.
The strength of the pound produced positive returns from Canada, Austria and the US in sterling terms. However, in local currency terms they too produced negative returns. The strength of the pound also boosted Japanese bond returns for UK investors.
Cole said the disappointing returns in 1999 had given back most of the gains made in 1998.
He added the relationship between bonds and equities, which has been the norm for the last 15 to 20 years, has broken down with investors appetites for risk increasing.
In his view bonds were following monetary tightening by the central banks, while equities followed the growth story.
He said in 1998 to 1999 aggressive tightening of monetary policy by central banks had turned GDP growth around and avoided a collapse of the world banking system.
In the UK alone GDP grew by 2.9% compared to consensus of 1.9%. Inflation remained low, although the bond market had been concerned that low inflation would come to an end and it feared central banks had been too aggressive in their stimulation of the global economy.
As a consequence there was widespread expectation that short-term interest rates would have to rise.
Cole said supply and demand dynamics further inverted the yield curve.
The long end of the yield curve did not move during 1999, as improving government finances fuelled expectations that there would be a reduction in the amount of debt which would be issued, raising the prospect of potential shortages.
Cole noted the completion of the next generation mobile phone licences auction is set to boost the budget balance surplus from a consensus forecast of £7.3bn to £23bn.
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