The US Federal Reserve is unlikely to increase interest rates for some time, keeping a floor un...
The US Federal Reserve is unlikely to increase interest rates for some time, keeping a floor under Treasury bond prices.
At 1.25%, the Fed Funds rate is at its lowest since it became the primary tool of monetary policy. The last policy move was a 50 basis point easing in November, the 12th cut since easing began in January 2001.
Merrill Lynch Investment Managers bond strategist Andrew Roberts believes even with bond prices at record highs, Treasuries are still a strong bet.
'People are focusing on when the Fed might stop cutting interest rates and start buying Treasuries but you need to remember we are going to get interest rate cuts first,' he says.
Continued weakness in economic data and equity markets means Treasuries still offer good value, Roberts adds.
'The curve has been steepening as short-rate expectations continue to come down,' he says. 'I still think there is scope for further interest rate cuts and lower yields at the shorter end of the curve.'
Roberts believes unhedged UK investors should be aware of the possibility of a sharp fall in the US dollar against sterling, citing the enormous US current account deficit, negative real short-term interest rates that are still falling and lack of yield compared with other markets.
One way of circumventing this risk is to invest in inflation-linked US Treasuries, known as Tips, because a sharp fall in the dollar can be expected to boost inflation.
'In economic terms, there will never be a better environment for inflation-linked bonds, with growth flat on its back and real short-term interest rates being cut by central banks, which are attempting to create inflation,' Roberts says. 'It doesn't get any better than this.'
First State head of global fixed interest Kevin Calglazier believes there may be a mild sell-off of bonds as investors take profits following the rally of the past few weeks, especially while the market is prone to a setback on any news of a lessening of geopolitical tensions.
'The news has gone pretty much one way only in that regard, so there is a tactical opportunity for a pullback, but that's not necessarily the best strategic move as I don't think the upward move in bonds is over,' he says.
'I don't think any sort of step-back in the Treasury market should be seen as the beginning of a trend towards higher yields, because we're a long way from sorting out what happens in Iraq. There are other geopolitical issues pending and I don't believe Iraq is the fundamental issue in the US economy.'
Calglazier says tensions over North Korea are likely to keep markets nervous and therefore keen on bonds once the Middle East situation is resolved.
'None of this changes the fact the US economy is weak, although not recessionary. It is growing at a sub-trend rate because it is still working off the excesses of the 1990s bubble,' he says.
Calglazier feels there is a good chance interest rates will be eased again, but only slightly, because cutting interest rates down to zero has a negative psychological impact as well as discouraging saving.
'Dropping cash rates may smack of despair but they are not going up any time soon,' he says.
Interest rates expected stay low.
Inflation-linked bonds good value.
Uncertainty boost bond demand.
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