A better year than last
Bond markets will enjoy a better year this year than last, say fund managers. However, as 1999 was such a miserable year for the mainstream government bond markets across the world, to say that this year will be better may not mean very much, admits Paul Read, European fixed income fund manager at Perpetual in the UK. He adds, “Although 1999 saw yields backing up a lot everywhere, and especially in the US, we are still not bullish on government bonds anywhere. We cannot see how they can rally when global growth is picking up, commodity prices are continuing to rise and inflation, though not about to take off, is steadily ticking up.”
While prospects for government bonds continue to be poor, certain debt instruments should do much better as economic activity increases. Read is particularly enthusiastic about European corporate and high yield bonds. “A bit of economic growth is good for the issuing companies’ own finances,” he says. “And both sides of the demand/supply equation look good in Europe at the moment. We have increasing demand from investors seeking higher yields, as government and supranationals continue to offer single-digit coupons, and there’s also an increasing equity culture within Europe that is leading to an increasing awareness of credit analysis. On the supply side, there are lots of reasons for issuers to come to market: look at the telecoms sector, which is financing huge pan-European restructuring via high yield bond issues.”
Paul Brain, head of fixed income at Investec Guinness Flight in London, agrees that the new year may herald a rather more comfortable time for bond investors than 1999, although he argues that the house’s interest rate outlook is slightly more bearish than the consensus. He explains, “We believe that the market is not quite pricing in sufficient rate increases from the Fed, ECB and the Bank of England. We think the Fed, for example, has another 25 basis points, or possibly even 50, still to do. That said, even we are not looking for inflation to be a problem. However, we think that the market will start to scare itself about inflation in the near term, which is why we’re bearish. The very flat US yield curve – two years at about 6% and 10 years on 6.3% – suggests that if short rates move higher, then long rates will have to move also. We cannot build an inverted yield curve into our forecast just yet.”
Yield curves in Euroland are already significantly steeper than in the US and so Brain argues that the outlook for Euroland bonds is slightly better, although with the economy picking up and growth being more balanced – with even Germany and Italy, 1999’s growth laggards, doing better in 2000 – the environment is still not that healthy for fixed income assets.
Robeco Group in Rotterdam agrees that the steepness of European yield curves provides a degree of protection and offers scope for roll-down trading. Bob Galesloot, global fixed income manager, cautions that although overall they are neutral on European bonds they are underweight Euroland. He goes on: “We see a couple of themes being played out at the moment, which have to balance up together. Firstly, rises in Euroland and other stock markets have to be seen as dangerous for bonds. Take Sweden, for example, where the stock market has risen more spectacularly than most, suggesting rising economic growth in the future, with concomitant fears of rising inflation, all of which makes us more inclined to take a particularly bearish stance on this market. The steep yield curves, on the other hand, should counterbalance this.”
Slightly wary of Euroland itself, Robeco is instead trading spreads. Like the managers at Perpetual, who favour non-government and high yield corporate sector, Robeco has channelled resources into Greek, Hungarian and Polish bonds. Galesloot argues that Greece is probably the most interesting market, saying: “If things go according to plan for Greece, she should become a member of Emu on January 1 2001. The EU finance ministers have already removed the ‘excessive deficit status’ from Greece, so it only has inflation to get under control and we think the outlook there is pretty good and as the Greek government is continuing to make good efforts to contain inflation, we think they will get there, sooner rather than later.”
As for the beleaguered euro, both Investec Guinness Flight and Robeco believe that there may be further weakness to come. “The euro continues to be a very technically driven rate, and we still do not see that conditions are right to be bullish on the euro, especially versus the US dollar,” comments Galesloot.