Long-dated bond prices are expected to remain supported despite the lack of rate cuts in this month'...
Long-dated bond prices are expected to remain supported despite the lack of rate cuts in this month's round of monetary policy meetings.
The US Federal Reserve, European Central Bank (ECB) and the Bank of England's Monetary Policy Committee all opted to leave official rates untouched earlier this month, in line with most market expectations.
The yield curve has steepened in anticipation of a pick-up in inflation and economic growth but the Federal Reserve is still more concerned about the threat of deflation than anything else.
Stewart Cowley, head of global fixed interest at Newton, sees little point for the Fed to cut its rate, which is already at a historic low of 1.25%.
'The Fed has lost control of this and the effect of interest rate cuts is largely symbolic ' there is no real economic effect,' he says. 'If they think the economy is in trouble, they really need to get bond rates down.
'The only way they can do that is to use Japanese-style quantitative easing, which is when they start buying back their own debt.'
These unconventional monetary policy tools, flagged up in speeches by Federal Reserve governors, may be an attempt to talk down long-dated bond yields.
'It is easy to understand why they would use these methods, given that the yield curve is very steep in the US at the moment, inappropriately so for the kind of interest rate environment we now have ,' Cowley says.
Nonetheless, he adds, short-end intervention is likely if there are any further signs of economic weakness in coming months.
'We could end up with an inverted yield in the industrialised western economies for reasons of supply and demand for long-dated fixed interest assets and the possible manipulation of the curve by policymakers,' he says.
Cowley predicts the ECB will cut interest rates to below 2% during the summer, with the UK possibly following suit if concerns over the overheated housing market cannot be addressed.
Isis global bond fund manager Richard Stevens says the ECB took a big chance by failing to cut interest rates earlier this month.
'The recent appreciation of the euro is going to bear down on European inflation and will restrict the ability to export into a world economy that is pretty weak anyway,' he says. 'There is still plenty of scope for short rates in Europe to come down and the speed at which inflation falls in Europe may well surprise the ECB in months to come.
'The longer the ECB leaves it, the more it is going to have to cut rates anyway.'
Stevens says the steepness of the European yield curve is unsustainable, with implied economic growth far ahead of the likely performance in coming years.
'The whole yield structure in Europe can come down, because the forward rates the market is pricing in are just too high for what the economy is going to produce going forward,' he notes.
Accordingly, Stevens is positioned long in terms of overall duration. In the UK, a weakening pound and a relatively stronger economy means there is less scope for easing, Stevens says. He tips the Bank of England to keep rates steady for the time being, although risks remain that rates will come down in the next six months.
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