So the Fed is getting tougher, not that the half-point, as opposed to the more customary quarter-point, hike had any more meaningful effect on bond markets, where nervous anticipation (or is it discomfort?) remains the order of the day. Still, the accompanying rhetoric was reasonably vexed, with comments such as “increases in demand remain in excess of even the rapid pace of productivity-driven gains in potential supply”.
More excitement was felt in the currency markets as the battered euro took another hit and slumped below 88 cents. This time, however the euro had company, as sterling fell to a six-year low, taking its year-to-date decline versus the dollar to just about 8%.
And there are more US rate rises expected: Fed fund futures are pricing in another quarter-point hike by the end of June.
According to Mercury Asset Management’s Graham Bamping, the tough environment for bonds is unlikely to improve as long as central banks throughout the world are tightening rates: “On balance, however, the general world background is not overly bond negative – there are disinflationary forces still around, with rising productivity rates and increased competition – so we think that although we are in a bear market, interest rates globally are going to rise less than in previous cycles. The big ameliorating factor for global bonds, especially for US treasuries and UK gilts, is on the supply side. As long as budget deficits continue to fall and central banks look to buy back outstanding debt, then we are going to see more yield curve flattening or indeed inversion. We are currently running barbell strategies, with some longs and some very, very short bonds and avoiding the middle maturities. Overall we are either running at index duration or perhaps a little shorter.”
Geoff Lunt at Investec Guinness Flight thinks that the yield curve will trade flatter, or may even invert. He explains, “We have already seen some flattening, and it is not over yet. As well as following trends in the US, we have the telephone auction receipts to come.”
Kim Jansen, at Carnegie Asset Management thinks that bonds are range-bound, and that yields could go either way, but are highly unlike to break out of recent trading ranges. “We have seen something of a relief rally, starting in the US recently but on the whole markets have been incredibly boring. We’re stuck in the middle of this range and it will take some really important news to break out.”
That ‘important news’ might come soon, thinks Investec’s Lunt, who argues: “We think the chances of the US economy enjoying a soft landing are pretty low. There are some severe measures needed and we think Mr Greenspan and his colleagues are going to deliver them. There will be negative growth next year – how realistic is it to expect the economy to be gently slowed from over 5% annual growth to a more relaxed 2.5–3%? No, at some point there is going to be a global slowdown, and with central banks still articulating their commitments to control inflation, we are bullish on bonds throughout the world in the medium term.”
Lunt is quick to exclude Japan from global inclusion, suggesting that yields could easily spike up there and that the Investec global bond portfolios have been, and will remain, underweight Japanese bonds. He also admits to being slightly worried in the short term and thinks there has been some genuine disquiet as to how economies, in particular the European ones, will pan out.
He suggests that if the ECB does start to defend the currency the economic recovery would be hit and so European budget deficits may not be cut. He suggests, “There has been a clear flight to quality move across Europe, with German Bunds being the main beneficiaries. Germany’s economy is still perceived as the best run, and so would be the safest haven if economic conditions deteriorated. Look at the Italian 30-year – it has moved from 30 to 50 basis points over Bunds in the last week or so.”