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Bond investors are infamous for their seemingly dour outlook on life and the economic scene, preferring slow growth or recessions and Scrooge-like finance ministers gripping tightly onto fiscal policy. It has been a particularly depressing time these past few years with equity markets almost everywhere climbing higher and higher, as economies and the US one, in particular, continue to grow year after year with still no sign of inflation to spur the central banks to barge in and spoil their party. We may be in the midst of a change, however, as price swings on the NASDAQ, and the Blue Chip indices, get bigger and the one day drops more and more stomach churning. US Treasuries have been doing a great deal better than equities recently. For the first three months of the year, US Treasuries (as measured by the JP Morgan US Traded) finally outperformed both the S&P and the Dow, but was still behind the NASDAQ at that point, although even by then was showing clear signs of acute nerves.
The turnaround in the fortunes of the US Treasury market, and with it the rest of the developed world’s government bond markets, has not been greeted with too many cheers by many fixed income investors who had been expecting further ‘bad’ news for bonds, in the form of higher US inflation perhaps, to be dictating the market direction. According to Jaeme Arguello, head of fixed income at Swiss group Pictet, the recent bull market has been happening against a macro-economic backdrop that is still fundamentally bond-negative. He explains, “Since the end of last year, we have been expecting aggressive tightening by the Fed, because we believe US economic growth will continue to surprise on the upside. During January things went OK and we were well positioned as yields rose in the face of fresh news about the strength of the US economy and how much more the Fed might have to raise rates. Then, although the macro economic factors remained unchanged, the Fed announced its intention to buy-back Treasuries and NASDAQ started to wobble badly and investors began to switch out of equities and thus liquidity swung massively and sharply in favour of bonds.”
Although initially short, as the market started to rally, Arguello and the team at Pictet got better positioned later on and are currently neutral in US Treasuries. Pictet have also been trading their European bonds, as they began the year short and then moved to overweight at one point, although they have since pulled back to neutral here too.
The managers at CCF are also neutrally positioned, although they too are not that happy about the macro-economic outlook. Jean-Pierre Grimaud, head of the bond team, explains: “It is very difficult to be positive on global bonds right now. The rally of the last few weeks has been based on some very specific supply-side technicals and the ‘flight-to-quality’ argument which has also impacted both swap and credit spreads. I cannot remember 10-year swap spreads ever being as high as 140bpts before. Of course the OPEC agreement on oil production was always going to provide a lift to the market at some point.
“Most of what has been happening here is not Europe-related at all, it’s entirely NASDAQ and US Treasury influenced,” says Roland Lescure who heads up strategy and research at CDC Asset Management in Paris. “We look at the fundamentals in Europe and see a weak currency, strengthening economic growth to levels not seen for 10, 11, or 12 years even, and they are just not bond positive. However, when we got some genuinely good European news about the wage settlements in Germany the market did nothing, because the market had already gone too far. The spread between Treasuries and Bunds has come in some 40 basis points since the end of March, and we think that trend is bound to continue. Growth in Europe is getting stronger, and there will be a lot more ECB tightening. And we are not about to see bond buy backs yet, the stocks of accumulated deficits across Europe certainly preclude that sort of scenario.”
CDC are not expecting a big deterioration in yields, although believe that the 10-year Bund may reach a peak of 5.5% by the end of June before falling back down to around 5.2% by year end. In anticipation of the next move up in yields, CDC are running their European portfolio durations at about 70% of their index. CCF are somewhat more sanguine about the markets, believing that European government bonds will remain range bound for the next few weeks.
Although their government portfolios are overall neutral, they remain cautious on credit, believing that investors will remain risk averse and so believes that swap spreads will stay at today’s wide levels. Pictet are also reasonably relaxed that European bonds will be bound in a narrow range over the coming months.

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