By Gordon Brown, fund manager at Baillie Gifford The year 2001 will be remembered as a roller coas...
The year 2001 will be remembered as a roller coaster year for international bond markets. In the face of the sharpest global slowdown for almost 20 years, international bond yields fell steadily throughout most of the year, only for this to be wiped out in just over one month towards the end.
Prior to the terrorist attacks of 11 September, the global economic slowdown was already acute and well under way. The US economy was slowing into recession, growth in the euro area economies was stagnating and Japan was in the middle of its third recession in eight years.
The attacks heightened uncertainty and prompted a sharp decline in private activity. However, the sharp slowdown was not isolated to consumer retrenchment but also seen in manufacturing, trade, capital spending and employment.
In the face of this synchronised global downturn, the response from policymakers was swift and sizeable, particularly in the US. Short-dated bond yields fell in line with aggressive interest rates cuts and long-bond yields followed. The extent of the fall in long-dated yields was exacerbated by the announcement by the US Treasury that long-bond issuance would cease from early 2002.
Despite aggressive monetary easing, the consensus among economists was that interest rates would be cut further and that weak growth would continue through most of 2002. By the end of September, despite an already significant fall in yields, the bond market rally looked set to continue.
After the initial post-terrorist attack shock to equity markets had passed, stocks began to rally strongly. The views underpinning the rallies in the bond and equity markets were contradictory so this trend could not be sustained.
The rally in stocks and swift rise in global bond yields suggest financial markets are now firmly siding with the equity market view. Roughly translated, this means the US recession will be modest and short-lived, with growth and interest rates increasing through the second half of 2002.
Throughout last year, economic data was mixed and some economists believe the recovery will not be enough to soak up the excess capacity accumulated during the downturn. This slack will in turn keep a firm lid on inflation and encourage central banks to keep rates steady. They therefore do not see significant monetary tightening accompanying next year's recovery and consequently any sell-off in bonds is unwarranted.
The consensus predicts the huge monetary and fiscal stimulus in the US will be enough to overcome global recessionary forces and will pull most major markets out of the economic quagmire. In contrast to the US, the euro area economies should avoid a recession but the recovery in growth is expected to lag the US.
The exceptions to this are the UK, where growth has remained above average through the economic downturn, and Japan, which has its own unique set of problems.
Overriding this is sentiment among investors who appear more uncertain now about economic prospects than for many years.
Slow recovery in euro economic area.
Inflation to remain subdued.
Rates may not rise as much as the discount.
UK remains above average.
US growth and inflation higher than forecast.
Volatility in bond market.
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