Weaker economic data in the US and Japan could prove favourable for government bonds, according to F...
Weaker economic data in the US and Japan could prove favourable for government bonds, according to Fidelity International.
Mark Pearce, product manager for fixed income at Fidelity, says: "The US is slowing down, with the Federal Reserve indicating the tightening cycle is coming to an end. For example, the number of homes available for sale has increased to a level similar to that of the early 1990s' negative equity. Consumers have borrowed heavily against their mortgages and are spending less, and the Fed may need to cut rates to spur demand. We expect the yield curve to become inverted or interest rates to decline from 5.25% by the end of the year.
"This will be good for long-dated bonds as their yields are trading higher at 5% compared to short-dated bonds with 4.83%, meaning when interest rates fall they will give a better return for investors."
It is not only Fidelity that has an overweight position in 30-year long-dated bonds, Royal London Asset Management (RLAM) and Newton all have similar weightings in their portfolios.
According to George Henderson, fund manager of the RLAM Overseas Bond fund, the growing interest towards the longer-end has been partly driven by demand from pension funds. In the US, pension funds are required to reduce risk in portfolios by matching liabilities with less risky asset classes such as long-dated bonds.
Stewart Cowley, head of fixed interest at Newton, says: "There is not enough fixed interest securities for pension liability matching. Demand is not going to go away for long-dated bonds, which should see a higher return for investors."
However, one concern for Cowley, is the prospect of a weaker dollar if the US economic situation further deteriorates, as returns could be reduced for foreign investors.
He is hedging his bets and while he is buying in dollars he is selling in euros and yen - stronger currencies that will provide a higher return.
Meanwhile, Pearce believes a weaker US economy could be beneficial for Japanese government bonds if the economic situation in Japan deteriorates and interest rates do not rise quickly. He explains: "Although the Bank of Japan has increased rates because of higher growth, it is still not out of its deflationary environment. What happens to the country is still dependent on the rest of the world. Around 10% of Japanese exports are sent to the US; if the country slows and spending on these goods falls, the economy will be impacted."
He is overweight 30-year long-dated bonds yielding 1.85%.
In contrast, Henderson does not favour Japan. He explains: "The country is starting to recover from deflation; the Bankof Japan recently ended its zero interest rate policy with a July increase to 0.25%. We expect the government to continue raising rates, which would make bonds more expensive. We have an underweight position in inflation linked 10-year short-dated bonds, which are yielding 1%."
Newton does not hold any government bonds in Japan.
In Europe both RLAM and Fidelity are cautious as European economies start to pick up, with the consumer beginning to spend on the high street.
Henderson also believes ECB interest rates will rise 0.25% each quarter for the rest of the year from their current rate of 3%. For these reasons he is underweight 10-year short-dated bonds yielding 3.87% and overweight 30-year long-dated bonds yielding 4.1%.
US long-dated bonds should outperform
Japanese bonds favourable unless interest rates rise quickly
Managers cautious on European bonds
Cowardly, boring or sensible
Latest news and analysis
‘Most significant’ upgrade since launch
Changes happening over coming months
Had accepted British Steel business