Doing the right thing
Bond fund managers do not expect the outlook for bonds to improve in 2000. The consensus view seems to be that the cyclical backdrop for bonds remains negative with the global economy appearing to be entering a period of synchronised growth, which may cause investors to worry about the re-emergence of inflation.
According to Tom Joy at Schroders, the question for bond investors is how much monetary tightening will be necessary to ensure growth stays on a sustainable path and whether the pick-up in growth will feed through to consumer price inflation: “It is our view that any pick up in inflation will be modest, as firms appear unable to pass cost increases on to consumers due to intense competition. For this reason we feel that bond markets are currently discounting a lot of bad news.”
He suggests that the convergence theme in fixed income markets, which supported countries like Italy and Spain before they joined Economic Monetary Union, will spread to Eastern Europe: “Western Europe’s economic recovery will also support this trend, as strengthening exports will help to stabilise current account imbalances.”
According to ABN Amro’s European bond team, remarks by ECB board members has had an effect on other money market rates. “The ECB has repeatedly insisted that it wants to be clear in its policy on interest rates,” says ABN’s analysis. “Senior ECB officials have regularly stated that the money growth figure is crucial in deciding whether to put up interest rates.”
The money growth figures (M3) have been above the specified 4.5% target for several months now. M3 monetary growth figures are seen as the main indicators of future inflation. Further steps will depend on the future pace of economic growth in the Euro-zone and its implications for consumer prices. Recent analyses point to a 2% economic growth rate in 1999 and 3% in 2000.
Looking further ahead, ABN Amro believes the ECB will increase its refinancing rate before the end of next year by approximately 100 basis points. “At the moment we feel comfortable with the present average maturity of the IGF Euro Fund of four months. The data showed that interest-rate sensitive spending and activity sensitive to fading wealth effects [consumption and housing_investment] are starting to slow.
“European economies are benefiting from a sharp acceleration in export growth. The stellar performance of UK exports and improving manufacturing confidence suggest that the upturn in global growth has been an important factor. In Euroland manufacturing confidence is also gaining momentum, and the better outlook is starting to feed through into improved industrial production data. However, export performance in Euroland is also partly explained by the depreciation of the real exchange rate over the past year. The long-awaited money supply (M3) data for September that came out at a robust 6.1% year-on-year prompted a perverse market reaction and a dramatic reversal of sentiment. The market rallied 30 basis points, apparently on the view that the ECB would “do the right thing” at its November meeting.