The US economy is likely to go down further than the market estimates, according to Michel Gonnard, ...
The US economy is likely to go down further than the market estimates, according to Michel Gonnard, head of fixed income at Cazenove.
He says: "Recent interest rate cuts are not enough to rescue the economy and so good value in bonds is expected over the next quarter."
Paul Thursby, who runs Baring Asset Management's Global Bond trust, is particularly keen on US Treasury inflation-protection securities (Tips), which provide inflation-linked returns. Real returns are continually monitored and changed according to headline inflation.
Gonnard agrees, pointing out that conventional medium-term bonds are yielding slightly more than 5%. Taking into account inflation, the real return comes to about 2%. In comparison, Tips currently average a real return of 3.5%.
Gonnard expects Tips to perform well over the coming years. This is because it is a relatively new product in the US and therefore less sophisticated, whereas elsewhere, such as in the UK, the equivalent has existed for some time and the market has matured.
On the currency side, Gonnard expects the dollar to weaken relative to the euro. He believes Europe will be somewhat isolated from the expected malaise, but there will still be some effect and bonds should therefore do well. He adds that the longer end of the eurobond market is looking particularly attractive.
Thursby says: "The euro will recover and inflation will come in lower. Yields in Europe are 5.4% to 5.6%, so that's pretty attractive for investors."
However, the UK is more expensive and yields are low at close to 4%. Gonnard says this is down to technical reasons at the longer end, including MFR concerns and supply and demand.
He says: "Why should investors go for a 4% yield when German bonds are yielding more than 5%?" However, Thursby believes that as the infrastructure of the UK is in serious need of a cash injection, there will be mounting pressure on the Government to increase its spending. Bonds are therefore likely to be issued to ease the supply side of the equation.
Gonnard says: "However, for the next 12 months, UK bonds will trade in a very narrow range."
Sentiment on Japanese bonds remains negative. With yields at 1.5% and government debt mounting, Thursby is concerned about the ability of the government to support its debt without causing economic problems.
As far as corporate debt is concerned, the consensus is that estimates have been too high up to now and will have to come down. This brings into doubt the ability of some companies to service their debt, he says, and default risk is likely to increase as a result.
Gonnard believes the US slowdown will be harsher than the market expects, and so in the short term there will be a flight to quality in the corporate debt markets.
However, he says this will be only a negative in the short term because on a three to six-month basis the market will overcompensate for the increased risk in the asset class and this will make the area particularly interesting going forward.
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