UNITED STATES – Chicago-based banking giant Northern Trust sounded an upbeat note on the bond market, saying fundamental averages of bonds remained “strong”.
In its year-end outlook for fixed income, Colin Robertson, director of fixed income investment at Northern Trust, predicts a bond market “rout” is unlikely.
Robertson, who oversees some $200bn in fixed income assets, says the Federal Reserve’s tightening of interest rates did “not necessarily” spell a continued bear market in bonds.
“Many aspects of the environment for fixed income investing are extremely atypical of a tightening-rate climate,” he says.
Robertson cites the following reasons why the current environment differs from a typical Fed tightening cycle. First, the ‘busted bubble’ preceding the economic expansion has led to considerable, longer-lived caution among business owners and managements.
Second, “the elongated economic cycle supports sustainable growth, with excess capacity slow to dissipate, moderate job growth that lags the normal expansion trend and consumer/business confidence that remains reasonably solid,” he said.
Third, the Federal Reserve has to balance cyclical inflationary and secular deflationary effects while keeping growth on track. Robertson further argues the potential economic cost of tightening rates too aggressively is much higher than the cost of tightening too slowly.
In addition, he says the financial market responses to the recent tightening moves – US dollar weakening, flattening of the Treasury curve and tightening credit spreads – have been atypical.
“Looking forward, we expect inflation to move to a higher base level but remain well under control,” says Robertson. “Our forecast calls for Treasury rates to rise but the timing will be gradual and the degree modest. We don’t see this as the start of a sustained shift toward upward-trending interest rates.”
He adds: “The rate structure has priced in – and taken out – considerable Fed tightening over the next 12 to 18 months. So, don’t expect a dramatic 1994-style surge in Fed funds rates but rather a late-1950s-type rate event, when rates rose gradually over an extended time period.”
As a result of all of this, Robertson argues bonds will remain attractive for investors.
As of end-September Northern Trust had assets under administration of $2.4 trillion and assets under investment management of $535bn.
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