Over the last month, in the wake of the tragedy on 11 September, the atmosphere in the global capita...
Over the last month, in the wake of the tragedy on 11 September, the atmosphere in the global capital markets has been highly volatile, reflecting the increased level of uncertainty for the global economy.
In such an environment the outlook for global bonds is generally favourable on the back of a flight to quality, but the key to identifying long-term value lies in the underlying economic conditions. Prior to the terrorist strikes on the US, the global economy was already in poor shape.
The attacks have merely accelerated trends that were already in place, as well as greatly increasing economic and political uncertainty worldwide.
In recent months, economic growth forecasts have been declining across the globe, with the US very much leading the way. Having grown at 4% or above for much of the late 1990s, the economy has slowed sharply and grew only 0.2% in 2001Q2.
The slowdown in late 2000 and 2001 has been caused by three main factors: first, interest rate increases by the Federal Reserve during 2000; second, a sharp rise in the oil price from the $10 per barrel low; and third, a slump in capital investment. The sharp fall in capital investment has been a result of past over-investment becoming apparent and companies finding financing conditions less favourable.
The attacks have exacerbated these trends by undermining consumer and corporate sector confidence, which were already showing signs of weakness. Prior to the attacks, central banks had been responding to the economic weakness by cutting interest rates, particularly in the US. Post-11 September, their response has been to inject a large quantity of liquidity into the markets very quickly and cut interest rates aggressively.
Unsurprisingly, bonds have performed well in this environment, particularly at the shorter end of the yield curve, and going forward, the outlook for global bonds also remains good. While most of the interest rate cuts in the current cycle are probably behind us, the economic recovery is likely to be modest at best in 2002.
Many of the imbalances built up in the US during the boom of the late 1990s have yet to be fully resolved. In particular, private sector saving remains too low, which has contributed to the large and ultimately unsustainable current account deficit. For the current account deficit to decline, private saving is likely to have to increase, which implies only modest consumption over the next few years. In addition, capital spending is likely to remain weak for the next few quarters as companies continue to work off past excessive investment.
From an inflation perspective, there remains little to concern the bond investor, not even the much discussed fiscal loosening we anticipate will occur in an attempt to stimulate growth in the US. At Investec, we expect to see inflation resume its downward path, in the face of a stable/lower oil price and weaker labour markets in most major economies.
This decline in inflation is likely to support bond markets by enabling central banks to cut interest rates prudently and by raising the real return available on bonds.
Favourable outlook on back of flight to quality.
Inflation outlook positive.
Rally is likely to continue.
Private sector investment low.
Capital spending to remain weak.
Consumer confidence undermined by attacks.
Paul Griffiths is head of fixed income at Investec Asset Management
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