The longer end of the US and European bond markets continue to outperform, although two- to three-ye...
The longer end of the US and European bond markets continue to outperform, although two- to three-year bonds are starting to rally.
Peter Lucas global investment strategist at Ashburton is negative on bonds in the short term. He says investors are complacent, especially in the US, and expects growth to exceed predictions in the short term. He says: "A great deal of good news is already discounted. Bond yields and commodity prices are often closely correlated. What we are seeing now is that commodity prices are at a high and bond yields are near to a four-year low, this is a gap that has yet to be resolved."
He adds that there is a yield differential between what inflation-linked bonds and conventional fixed-income bonds are paying, a measure of long-term inflation expectations. The yield differential is currently 1.8% while the headline rate of inflation is 3.4%.
Lucas says: "The markets are already discounting a big drop in inflation, which is a big sign of complacency."
According to Richard Woolnough, fixed-interest manager at Old Mutual, investors are also keenly awaiting the outcome of the US election and the impact of the successful candidate's tax and spend policies.
Detlev Schlichter, fund manager at Merrill Lynch, says there remains a favourable bond supply picture in the US where the government has been buying back Treasuries. The government has been running a budget surplus for the past two to three years and projections are this will continue. He adds: "The perception is of a shortage of US government bonds, especially at the long end of the government yield curve with 30-year bonds outperforming in the US market this year."
Another theme driving the bond market is the cyclical one. Schlichter notes that central banks in the US and Europe have raised interest rates, which is not good for short-end maturity bonds but the shrinking supply is good for long-maturity bonds.
The slowdown in economic growth in the US and Europe has seen the market readjusting the growth outlook, which is beneficial for short-term bonds, says Schlichter. Two- to five-year bonds have started to outperform, with this happening in the US in the past few months and in Europe over the past few weeks. He says: "There was a very strong move to a steeper curve in late September.
"In general we have a positive outlook on bonds. We expect two- to five-year bonds to perform better than 30-year bonds in the coming weeks, except for the US where it is difficult to tell which will outperform."
Neither theme is present in Japan, Schlichter says. This is the only market where the government is running a huge budget deficit, which will lead to large issuance.
He notes there are some small signs of a recovery in Japan, where the central bank has recently raised interest rates, but adds "other bond markets are more attractive. Money is better invested in Europe or the US, than Japan."
Woolnough says: "Japanese bonds behave very differently to other bonds. The yields are exceptionally low but you cannot ignore them. They are as much as 25% of some indices."
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