Standard Life Investments is underweight Japanese government bonds in the belief prices here are goi...
Standard Life Investments is underweight Japanese government bonds in the belief prices here are going to weaken.
Euan Munro, investment director, fixed interest at Standard Life Investments, thinks the market could see two of its main planks of support, demand from commercial banks and private investors, having less of an influence going forward.
Munro says commercial banks have been buying government bonds recently because they saw a lack of profitable lending opportunities in an economy suffering from prolonged recession. Now that companies are beginning to increase capital expenditure, especially on technology, the banks have better lending opportunities and have less need to buy government bonds.
Private investors have also soaked up bond supply in the past but if they develop an attitude for mutual funds they too might give up on government fixed interest.
Munro says that with the supply of Japanese government bonds high and domestic demand looking likely to fall, international investors will have to step into the breech. The problem is that there is very little to attract the overseas investor because yields are already as low as 0.09% on six-month paper.
Standard Life Investments does have holdings in the five to 10-year area of the market to get exposure to the yen in fixed interest portfolios. These areas of the market are being held as they are delivering some yield, with 10-year Japanese government debt offering a yield of 1.83%.
David Cryer, fixed interest director at Clerical Medical, is also underweight Japanese government bonds, but has reduced the underweighting recently to get exposure to the yen.
He says: "Recent GDP figures were disappointing but the bottom has perhaps been reached and the outlook for the economy is constructive. This means the outlook is not constructive for the bond market."
Cryer expects the Japanese government to issue more debt in the shorter duration end of the market and is looking to avoid what he thinks will be a relatively rapid increase in yields in this area of the curve. He says the Japanese government is likely to concentrate issuance in bonds within the two- and five-year area of the market. The five-year Japanese government bonds is now yielding 1.2%.
Cryer is employing a bar-bell strategy in government bonds, holding cash and floating rate notes at one end and longer term issues such as 10-year paper at the other extreme. Cryer also expects 10-year Japanese government bond yields to operate in a trading range of between 1.7 and 1.9%.
Munro adds: "The last two quarters in the Japanese economy have been weak and there has been a technical recession but the market is looking through this with capital expenditure from companies in a strengthening phase, which is giving encouragement to the growth bulls.
"Government spending on public works is also going to pick up which will give the economy a boost. In an environment of recovery bonds are not going to do particularly well and they are starting from low levels in terms of yields."
He adds that corporate spending on IT should also prove to be deflationary.
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