Bonds have shown surprising resilience in recent weeks against an extraordinarily robust economic ba...
Bonds have shown surprising resilience in recent weeks against an extraordinarily robust economic background and a trend of rising interest rates.
This may seem surprising and something that has not registered with several influential commentators who began the year in a pessimistic frame of mind after the disappointing bond outcome in 1999. This might equally be explained by lack of interest; bonds are resigned to playing second fiddle to equities in a world in which technology-related stocks are carrying all before them.
The key issue for this debate is whether this recent strength marks a real turning point or whether prices will succumb to further unexpected bad news. Forecasts of global growth for 2000 are still being revised upwards, driven by the amazing strength of the US economy and by the forces of recovery everywhere else apart from Japan.
Despite signs of recognition by Alan Greenspan that new economic paradigm influences may sustain faster growth without triggering higher inflation, it seems likely that most central banks will continue to push up interest rates for as long as their economies remain buoyant.
This policy is unlikely to take much account of current inflation rates. These remain generally subdued, except in non-core eurozone members like Ireland and Spain. There is clearly a risk that central banks may overshoot consensus interest rate expectations if growth proves resistant to their early efforts.
General bond yields have already priced in anxieties about base rate rises. Markets inevitably err on the side of caution and disregard positive trends during phases of anxiety about rate rises. Fund managers may not have recognised the potential of high yield sectors such as emerging market sovereign bonds and high yield corporate bonds, which positively benefit from the robust economic background.
Once it becomes apparent that the current round of interest rate rises has ended - and certainly in the last bear market in bonds in 1994/5, fixed interest yields peaked with the penultimate US rate rise - investor sentiment should improve significantly. This point would gain even greater weight if equity markets were shaken from their current heights. However, there may be pauses in an upward cycle while central banks take stock before the next key decision. Meanwhile, there are positive signs for bonds. One is the fact that those same interest rate rises will help suppress inflation. Another is the deflationary impact produced by a powerful cocktail of increasing globalisation, more intense competition between companies and the e-commerce revolution.
More and more companies are making substantial reductions in costs by adopting the internet to revolutionise their supply chains: BP Amoco recently disclosed that 95% of its supplies were sourced in this way. Furthermore, increasingly healthy public finances in G7 nations (with the exception of Japan) are leading to lower issuance of government debt, creating an advantageous imbalance between limited supply and heavy demand.
John Hatherly is head of research at M&G Group
Data quality is key
Granted leave to appeal the judgement