Although the long end of the US Treasury market has rallied significantly since the start of the year, most investors believe that this is a supply-driven move and does not mean that we are yet out of the bear market. Rate rises from the ECB and the Bank of England have just been announced and more hikes expected from both them and the Fed in the coming weeks and months.
The Federal Reserve and the Bank of England are well into their monetary tightening actions and the end of the bear markets may be nigh. Clariden’s Martin Hueppi is one of the less optimistic managers saying: “Last year was bad for bonds and we do not think that there will be much improvement this year. European bonds are still basically following the US Treasury market and the environment continues to be bond-unfriendly, both over there and here in Europe.” Hueppi argues that the key issue for Treasuries, and European bonds is what the US stock markets may do, suggesting that a sharp fall in equities would change dramatically his bearish outlook for bonds. Clariden are forecasting 10 year Bunds to drift higher and to end the year at about 5.70/5.80%. They suggest that 2000 will be a good year for corporate bonds and will be looking to switch more of their Government holdings into European credit markets, although Hueppi is no fan of the highest quality bonds, saying: “Why buy an AAA bond? It can only be downgraded. We think there’s far, far better value to had moving down the credit scale.”
Jonathan Cunliffe at Lombard Odier is also firmly in the bear camp, saying: “We think short rate expectations are too low in terms of policy from both the Fed and the Bank of England. I do not wholly buy into this New Paradigm thing, and the short ends are going to come under further pressure in the coming weeks.”
Barclays Global Investors take a more sanguine view of the Treasury market. “We think US Treasuries are quite fairly valued at the moment and that a reasonable amount of tightening is priced into the shorts,” says fixed income strategist Andrew Wealls. He believes the outlook for European bonds is poor, arguing that ECB monetary policy is still loose and that the market has not priced in enough future rate rises.
One of the more bullish US forecasts is from BNP, who believe that yields are high enough and have priced in sufficient bad news. Juli Collins-Thompson goes on: “Although we are not looking for a strong rally, we think that the short end of the market is too aggressive in its outlook for rate hikes – the Eurodollar strip curve is pricing in another 100 basis points of tightening by year end. We think the Fed will only hike rates by about half this. The TIP/bond spread has widened suggesting that the market has increased its inflation expectations . Our forecasts suggest that inflation will remain benign, although commodity prices have risen and inflation may well rise further. Wage growth, on the other hand is still very subdued even though the labour market is very tight.” BNP see the Treasury curve continuing to flatten, and highlight the 5-year area as representing best value.
While arguing that US Treasuries may be past the worst, BNP is sure that there is more bad news in the pipeline for European bonds. Collins-Thompson explains: “Unlike its US$ counterpart, the Euribor strip market is underestimating the extent to which the ECB will have raise rates and that bonds will come under pressure. The latest ECB rate hike was a smart move, and helped the bank’s credibility as a pre-emptive inflation fighter. We think that they will hold off acting after the next meeting but will move at the end of March. Interestingly , BNP think that 5-year bonds in Europe also offer the best outlook, although Collins-Thompson is quick to point out this is in terms of a falling market, and that they believe this sector holds the best chance of losing the least money!