Long-dated government bonds in Europe and US should perform well on the back of interest rises in Eu...
Long-dated government bonds in Europe and US should perform well on the back of interest rises in Europe and the cycle peaking in the US, according to F&C and Insight.
Strategists at the two groups have been advising their fund managers to remain positive on long-dated bonds in Europe.
Although F&C and Insight have underweight positions in Europe, both have overweight strategies in long-dated eurobonds for their fixed income funds.
Lucy Speake, head of European fixed income, at Insight, says: "The European Central Bank (ECB) has increased the repo rate for the second time in this cycle from 2.25% to 2.5%, which has led to a rise in short-maturity bond yields.
"We see better value in the European market in long maturity bonds. They tell a different story because they have not followed shorter maturity yields and have instead reflected stronger institutional demand. We are also mindful of the threat the European pension fund industry could follow the trend set in the UK of growing demand, high prices and falling yields."
According to Helen Roberts, head of government bonds at F&C, long-dated bonds will benefit the most from further interest rate rises. She explains in Europe consumer spending has picked up, business confidence is upbeat and core inflation seems to have stabilised at a low level, but headline inflation is above 2%. More specifically in the Netherlands, she believes long-dated eurobonds should be supported by demand from pension funds ahead of new Dutch regulations on asset/liability matching.
F&C prefers US treasuries to European bonds as US economic growth is expected to slow over the year and interest rates are approaching a peak. F&C has an overweight position in US long-dated bonds and an underweight in seven to 10 year treasuries. Roberts says: "We expect US growth to slow after a strong first quarter in 2006 in response to higher interest rates and a likely softening of the housing market. This could affect consumer spending and as a result lead to further weakness over 2006. After the rate increase in March, the Federal Reserve is likely to raise interest rates again from 4.75% to 5% in May 2006 given the upside potential of core inflation.
"As investors have been speculating about the timing and level for the peak in US rates since the fourth quarter, the treasury market is expected to be well supported over the remainder of the year. The yield curve may flatten further in the second quarter."
Both F&C and Insight are neutral in UK gilts. Chris Hartley, head of fixed income product management at Insight, explains: "The demand for long maturity bonds from UK pension funds has pushed prices up and led to both conventional and index-linked gilt yields falling to record lows this year.
"The pension fund industry is currently looking more at protection, particularly with regard to interest rate risk, than price. The Government is set to issue more long-dated bonds during the coming fiscal year and so we will see some alleviation in pressure and this may eventually lead to high yields later this year."
Roberts also says investors are not expecting any change to UK interest rates, which are currently 4.5%. F&C's strategic view on the UK is gilt yields may fall by the end of the year as global and domestic economic growth slows and US interest rates peak.
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