More confidence about
Global bond fund managers are becoming more confident of the prospects for European bonds as we approach the millennium. Jeremy Yates Edwards, manager of the Baring International Bond Fund and the World Bond Fund has been pleased to note that the long Euro strategy has finally been rewarded.
At the start of the year, he was expecting bond weakness after the rally seen in 1998 and the fund was positioned accordingly. While his underlying duration strategy was appropriate, the currency preference was clearly detrimental to overall performance in the first half. This position has now reversed and Yates Edwards argues that some stability in the euro/dollar rate is now the most likely scenario, with a bias in favour of euro strength.
In terms of strategy for the Internat ional Bond Fund, Yates Edwards has been actively increasing the weighting to US treasuries and away from European bonds. He argues that interest rates in Europe have now troughed and that the next move in rates will be up. The ECB however, will be in no hurry to raise rates as growth is likely to remain sluggish.
Yates Edwards believes the outlook for bonds will improve materially as we enter the new millennium. Central banks remain extremely hawkish and appear willing to react to the merest sign of inflationary pressure. The global economy is expected to show further signs of strength, but not at the expense of inflation.
Peter Geikie Cobb, manager of the Mercury ST US$ Global Bond Fund argues that the deflationary forces that were in place in 1998 have not abated but that the worst has clearly past. Investors are increasingly concerned that synchronised global growth will become an issue for inflation and this continues to be reflected in bond pricing. Geikie Cobb maintains that inflation is still not an issue as companies lack pricing power.
At current levels, he believes that European bond market offers good value, while the US market is more finely balanced. He expects a clear buying opportunity to emerge for US bonds once a level of rates is attained that begins to slow the US economy. Japanese bonds remain firmly out of favour and if growth fails to materialise, further debt will be issued as a pump priming exercise. If growth does accelerate, yields will rise to the detriment of the bond market. The Mercury fund therefore maintains a significant underweight position in Japanese bonds, an overweight position in long-dated euro paper and a neutral position in US bonds.
Newton ís head of fixed interest Helena Morrissey correctly identified a further period of outperformance by equities over bonds during the summer. The yield has been stubbornly range-bound but continues to recover as it approaches the 6.25% lows. At current yield levels, Morrissey says the bond markets appear to be pricing in an excessive inflationary risk and she maintains her view that yields will contract on a medium term view.
The sell-off in long dated Euro- zone bonds has prompted her to increase the weighting to core European bonds with the Newton UGF International Bond Fund. The current shape of the yield curve in Europe implies that a great deal of monetary tightening is anticipated which is unlikely to be realised given the relatively weak economic recoveries taking place in Europe. Morrissey agrees that there is likely to be further volatility in bond markets, which will become increasingly nervous about improvements in economic activity globally. The extent of the sell-off in 1999 suggests that much of the potential inflationary pressures have been discounted.
Paul Brain, manager of the Investec Guinness Flight GS US$ Bond Fund has been correctly calling the bearish tone for bonds throughout the year. He argues that continued Fed tightening is a real possibility before the year end and that inflation will continue to accelerate if only because of the strength of the oil price. Brain remains a buyer of the US long bond at yields approaching 6.2 % but acknowledges that some overshoot on the downside is possible. The duration of the IGF portfolio, at four years, is bearish and reflects a lack of conviction that the current trading range can be decisively broken in the short term. He continues to bepositively disposed to the US dollar as the relative economic growth rates compare favourably with those in Japan and Europe.