Wim Duisenberg’s recent comments at the ECB, which suggest a rate cut is unforthcoming, have disappointed the market, but no one can quite believe that a further cut can be avoided. 1, dispersion on the board will delay agreement – one could argue that monetary policy is too loose for Spain, yet too tight for Germany – but European macroeconomic fundamentals remain gloomy, and investors are beginning to realise that they were perhaps too optimistic in their outlook this year. In Euroland, the short end does not seem to have priced in enough, and, in spite of the low yields, there is still some value to be had. Peter Welling, a senior portfolio manager at Metzler in Frankfurt is among those expecting further cuts of up to 50bp in the coming months, and therefore, a steepening of the curve. Indeed, now that the situation in Iraq seems to have settled down, it’s back to the economy, he says, and time to “wake up to economic reality”.
From the Fed a cut is also on the cards, so the short end there is preferable, but fund managers are unsure of why Bunds are not trading through Treasuries. “With Germany staring deflation in the face, you could argue that Bunds should be 50bp through Treasuries – not 50bp over,” says Mark Talbot, head of international bonds at State Street Global Advisors in London. Jonathan Cloke of Legal & General Investment Managers agrees, but is not as keen on the very short end. “We could see a further 20bp-30bp of outperformance at the short end, but we are more positive on the five to seven-year area, where interest rate expectations are more focused.” Further along the curve, the consensus is neutral.
Positivity for the corporate bond market has also decreased slightly over the past four weeks, and some fund managers argue that it is becoming a little expensive, but technicals are supportive for the market, and value can be had. With government bonds offering such low yields, demand for corporate bonds is high, and the asset class is being suitably underpinned. Talking points are the telecoms and automobiles sectors for different reasons. Patrick Hendrikx, head of global credit and F & C in Amsterdam favours telecoms naming France Telecom and Deutsche Telecom. The value with telecom companies lies with their deleveraging strategies, and the lengthening maturity profile of their debt in a bid to improve their balance sheets. Less supply is expected from the autos sector also. “Car manufacturers have shifted their attention from the bond market to the asset-backed market. They can raise up to 35% of their financing requirements through the ABS market, so much less supply will be seen,” says Hendrikx. Welling, however, points out that the auto sector itself is currently so bifurcated that each auto company has to be looked at separately: “You cannot compare Ford with Renault for example, even if they are in the same rating category.”
Overall supply in the corporate market is expected to be less this year. Hendrikx is expecting 20-25% less in the way of supply than 2002, which is positive for the market as a whole. Bolstered further by an increasing amount of redemptions, demand should ensure the corporate bond market remains underpinned for the next few months.
Interestingly very short-term issuance, such as commercial paper has been replaced by longer-term debt this year. Although this short-term debt is still quite cheap, the move to longer debt is positive for corporate bonds, reducing risk for companies, explains Hendrikx.
While positivity remains moderate in the corporate and government debt markets, high yield has enjoyed a fruitful start to the year, with US high yield debt the best performing asset class of the first quarter. Lower-rated high yield issuers are still not recommended, but around the Triple B, and Double B area spreads look likely to tighten as companies reduce their debt.