Government bond markets are a safer investment than the corporate market where no sector provides a ...
Government bond markets are a safer investment than the corporate market where no sector provides a real safe haven, according to fund managers.
In most Government bond markets, there is likely to be little change unless market conditions alter significantly, but there are growing opportunities in Eastern Europe as countries in that region draw closer to joining the EU.
Sandra Holdsworth, executive director at Threadneedle and manager of the company's global bond and European bond funds, is fairly sanguine on her outlook for government bonds.
Banks are unlikely to tighten monetary policy, inflation is unlikely to rise and data suggests the economic environment will continue to be supportive to government bonds, she says.
She has a slight preference for European government bonds over the US. US government bond yields have risen to above 4% from their lowest level since the late 1960s, but are still not equal to Europe and the economic outlook in Europe looks more gloomy, she says.
Following the recent Irish 'yes' vote to EU enlargement, Eastern European government bonds are more attractive.
The EU will now go through negotiations about the first wave entrance of Poland, Hungary and the Czech Republic, so the bonds of those countries in particular should fare well, says Holdsworth.
The only problems could be the illiquidity of those markets and if any governments refuse to meet EU guidelines for entry.
Holdsworth is cautious about the corporate bond market. It is a difficult market, she says.
The latest sector to experience problems has been US car companies. General Motors was recently downgraded on credit ratings and Ford was given a negative outlook in view of pension liabilities. There is a possibility they could become junk bonds.
Any sector can be hit by similar problems. The financial sector, insurance companies, European banks and utilities are all unsafe, although UK banks and German utilities are regarded as safer. Fear in the corporate bond markets is causing investors to sell, says Holdsworth.
However, one area which has performed well is quality tech companies, she adds.
John Godley, head of global fixed income at Sarasin, shares the view that corporate bond markets are unsteady.
Corporate bond markets will continue to be volatile going forward with cars and communications the most uncertain, he says
Government markets have fared well year to date and will continue to on the back of poor equity markets, he adds.
He believes there could be a stabilisation in corporate bond markets in the next three months and says if he buys corporate bonds the bulk will be in the UK where bankruptcy laws are reasonably bond friendly.
Fund manager comment: SWIP
For the past 20 years, central bankers have seen their main task as holding down inflation. Low and stable inflation creates the circumstances under which economic growth can flourish.
Recently, however, there has been an apparent shift in central bank thinking. With the global economy fragile and inflation very low, concern has shifted to the risk of a debt-deflation cycle. The worry is that highly geared companies may face a punishing burden of debt, forcing them to cut employment and liquidate assets at distressed prices.
The change in thinking is not limited to the US. Europe's central bankers are showing increasing concern over economic weakness, particularly in Germany. Even in the UK, there has been some knock-on impact. The monetary policy committee's interest rate decisions have become increasingly driven by the downside risks to global activity rather than domestic developments.
On the face of things, this has been good news for government bond markets. The prospect of sustained low interest rates has helped to pull yields down, producing capital gains on existing issues. But investors now face a dilemma over whether to buy bonds on what are historically low yields. For policymakers, low yields on longer-dated instruments are part of the solution to weak economic activity and depressed equity markets. For bond investors, low yields imply significant risks.
Certainly, it is true that the global upturn may be less robust than many seen over the last 50 years. It is probable that in a year's time, central banks will be looking at a situation in which a recovery is well established and the risks of deflation are much diminished.
As a result, central banks will move policy back to a much less accommodative setting. But before then, government bond yields are likely to start adjusting upwards as investors sense the phase of cheap money is coming to an end.
Richard Dingwall-Smith is chief economist at SWIP
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