As the debate continues to rage on the likely timing and scale of any global economic recovery, one ...
As the debate continues to rage on the likely timing and scale of any global economic recovery, one thing is certain. There will be more government bonds issued over the next couple of years. One must return to fundamentals ' supply and demand.
Remember the macroeconomic factors affecting budget deficits ' supply ' are affecting investors' demand for bonds. Deficits are increasing due to lower tax receipts brought about by a drop in economic activity. This raises the supply of bonds. Yields have been falling as short-term rates are cut and inflationary expectations fall. This increases the attractiveness of bonds and increases investors' demand. There is an in-built stabilisation mechanism at work.
Cyclical fiscal deficits in isolation do not necessarily have a negative impact on yields as seen in the UK in 1992/93. At that time the borrowing requirement swung from being in balance to the biggest deficit ever seen (£45bn). At the same time the 10-year gilt yield collapsed from around 10% to 6% as investors took on board the economics of recession.
While the swing from surplus to deficit in the UK is meaningful, it is nothing like the scale of the early 1990s ' the fiscal arithmetic is dwarfed by other considerations. Some estimates predict a switch from equities to bonds of up to £100bn over the next year or so. This will make the yield cycle for bonds more complex than it has been over the last decade. This time around, the issues of supply and demand will involve corporate and not Government bonds.
Alex Smitten is a fund manager at Cazenove Fund Management
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