UK bond markets are performing strongly compared to their global equivalents with UK corporate bonds...
UK bond markets are performing strongly compared to their global equivalents with UK corporate bonds showing strong performance.
Investors have broadened their investment universe in the corporate bond market in response to alteration in pensions accounting, with pension funds now dropping down the quality scale and seeking positions in AA-rated bonds.
The cycle of UK interest rate cuts is not expected to go much further, and in the US, few managers are expecting further cuts. Some even believe the Fed might have taken monetary easing too far already.
Douglas Roberts, investment director at Standard Life, says: 'We are beginning to anticipate that we might be getting close to the end of the cutting cycle in the US. Retail sales figures have been up much more strongly than expected and the Fed may have done enough to end the interest rate cuts.
'In the UK, we may be getting towards the end of the interest rate cutting cycle,' says Roberts. 'Inflation figures are higher than people are hoping for.'
In the bond markets, yield curves have steepened and interest rates are expected to be on the rise in the next year.
Stephen Snowden, investment manager at Aegon Asset Management, says: 'Our view on fixed income on a global perspective is that bond markets will go down and yield curves will rise.'
Snowden expects the economic recovery in the US will be much stronger and quicker than expected, but he says the market has not priced in this V-shape recovery.
The US view contrasts with Aegon's view on the UK. In April it changed its position in UK bonds from underweight to neutral. Snowden says the yield curve is now flat due to the change in accounting standards for pension funds, allowing pension liabilities to be discounted at AA yields and encouraging them to invest in corporate bonds.
Last year, says Snowden, investors bought AAA-rated bonds. This year, investors have dropped down the credit quality to buy AA-rated bonds for yield pick-ups. They have targeted banks and higher quality corporates.
In the UK, there has been relatively strong supply for domestic demand. However, Snowden expects it to level off and says the majority of corporate spread tightening is over.
He says there was a flattening of the market because of the cuts in rates but, since then, the market has rallied because of good CPI figures.
Alex Smitten, a fund manager at Cazenove Fund Management, says: 'The question on everyone's lips is whether the rally in equity markets signals an end to the turmoil of recent months. Bond markets are influenced by sentiment generated in the equity markets as well as by concrete macroeconomic data.
'In fact, while the rally in bond markets at the end of 2000 was largely sentiment-driven, we are hungry for evidence of occurrences in the global economy.'
In the UK, he says, the signs are difficult to read, with a weak manufacturing sector balanced by a still robust consumer market and sticky inflation in Europe and the US offset by deflation in Japan.
He says the Bank of England's MPC has more than enough scope to deal with any eventuality, as evidenced by the fact that the UK has the lowest inflation rate but the highest interest rates in Europe.
Corporate bond supply/demand level.
Pension funds buying AA-rated corporates.
UK has scope for interest rate cuts.
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