The monetary policy outlook remains supportive for bond markets despite record high debt prices, as ...
The monetary policy outlook remains supportive for bond markets despite record high debt prices, as uncertainty dogs prospects for economic and equity market recovery.
Old Mutual's head of fixed interest Sofia Skalistiri says despite the US Federal Reserve's decision to ease the Fed Funds rate by a larger than expected 50 basis points earlier this month, further cuts cannot be ruled out.
'Nobody is prepared to exclude further action from the Fed should it be necessary, the Fed itself said that,' she says 'We are not expecting any real uptick in inflation, despite the recent economic figures.'
Skalistiri notes the ECB and UK central bank have yet to ease rates, while the Swedish central bank's decision to ease this month and dovish signals from the ECB indicate a move may be on the cards.
'Worldwide interest rates have not yet reached a bottom and are still supportive for bond markets,' she says.
However, a major rally is unlikely as the end-of-year accounting period draws near and managers avoid taking large active positions.
The renewed appetite for equities is also gradually eroding some of the safe-haven support for bonds, although continued tensions in the Middle East and the threat of further corporate collapses are expected to keep many investors on the defensive.
Merrill Lynch global fixed income portfolio manager Gareth Fielding feels the short-term outlook for bonds will be driven by uncertainty over the timing and nature of the economic recovery.
He says: 'It is partly going to be hostage to what happens in the US equity market and the appetite for risk there, which we think is likely to stay low as long as there is uncertainty over Iraq and the economy.'
The low inflation environment continues to render yields on long-dated bonds attractive, he adds.
'Looking out on the yield curve, the 30-year bond is still trading at 4.9%, compared to 1.9% on the two-year note. A 300-basis point pick-up for extending up the yield curve is attractive in a low inflation environment,' says Fielding.
However, with US government spending set to increase at the same time as taxes are being cut, speculation has grown that the 30-year Treasury bond will be re-opened, which would remove the scarcity premium boosting the price since the decision to cease issuance last year.
'A yield of close to 5% is a very attractive, low-risk return but if they issue a bucketload of them, that won't be the sharpest move you could make,' Fielding says.
Fidelity senior fund analyst Alex Tarver feels the low yields being paid on many investments will boost interest in lower-grade bonds.
'People aren't getting anything on US mutual funds that are holding cash so they need to look elsewhere for income, which is the big thing everywhere,' he says. 'They will look to corporate bond funds, because gilts are not yielding much above inflation.'
Isis's head of credit, James Foster, believes the Fed easing has already had a significant impact on high-yield bond prices.
'Prices have been discounting a sustained and very high level of defaults but interest rate cuts in the US have changed the outlook, with confidence recovering,' he says. 'This is feeding through to high-yield bond prices.'
Further monetary easing possible.
Economic uncertainty supportive for bonds.
Low inflation good for long-dated bonds.
Equities may outperform bonds in short term.
Rally unlikely before end of year .
Increased government issuance in 2003.
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