After months of hectic volatility in the bond and currency markets, investors may be allowed to relax a bit as we go into the summer.
“The recent string of weaker US economic reports has left the financial markets in a state of near euphoria,” comments Robeco Group’s Bob Galesloot. “We have seen a dramatic change in the near term interest rate outlook. Before the May jobs figures came out recently, it was taken for granted by the markets, that the Federal Reserve would have to raise the Fed Funds rate by another 75 basis points. Now, however, there is discussion of whether rates will be raised at all.”
Galesloot is sceptical of the market’s enthusiasm. He compares the to-ing and fro-ing action to a period back in the late 1980’s, adding: “At the end of the business cycle it was a similar picture and it was equally difficult to play it then too.” He admits that it has been a frustrating time for bond fund managers. “It turned out to be hard to time and capture the yield rises in January and April and also the declines in February, March and May, as the market swayed back and forth between fears of higher inflation and the comforting thoughts that growth was slowing down and inflation remai under control.”
Galesloot says he and his team would not be surprised to see the mood darken as thoughts returned towards inflation fears again, adding: “A slowdown of economic growth does not necessarily mean lower inflation right away. Inflation is a lagging indicator in the cycle and commodity price indices are still in an uptrend.”
Insinger’s Alex van der Speld agrees that investors are chopping and changing their minds very quickly. He goes on, “About a month ago we were all worrying about the US economy overheating and the dreaded inflation re-appearing. Now it’s back to soft landings and benign inflation outlooks. Nothing fundamentally changed in that period, it is purely investor perception swinging from one side to the other.”
According to Galesloot, the performance of the continental European economies has continued to be pleasing, with consumer and producer confidence numbers pointing to higher growth and still inflation remaining moderate. “We know that the European business cycle is lagging behind the American one, and so the upswing in Europe has a bit further to go. However, we expect 2000 to be the peak year of the current cycle both here and in the US.”
Although from a long term perspective, Galesloot is bullish for bond markets, arguing that growth will slow down and inflation will be kept in check, he is in no doubt that the road ahead will be a bumpy one for bond markets. Accordingly, Robeco’s global bond portfolio’s are, for now, remaining neutral within the dollar bloc, Europe and Japan.
Within Europe, head of ABN AMRO’s Global Markets Group, Alan Higgins suggests that now the Greek convergence play is over, the market will be looking for the next candidate. “It might be Poland. As for the rest of Europe, frankly it is still rather dull. We think the European bond markets’ correlation with US treasuries will remain high for the time being. In the US we think that the slowdown which seems to be in evidence just now, will not be sustained and our forecast is that the Fed will tighten more than the market is currently pricing in. If we are right, then the front end of the curve is vulnerable. Although fundamentally long rates should rise too, we think that the technicals will remain sufficiently strong to support the long end.”
Dominic Pegler, fixed income fund manager at JP Morgan, says that his team are more sanguine about the prospect for bonds. “Our outlook suggests that global growth has indeed peaked, and with that view becoming more and more the consensus within the market, it is quite difficult to see where the next move in bond yields would originate. We favour a soft landing outcome for both the US and the Euro-zone. In that environment, we think that bond markets – ex Japan – should earn their yields, and that there is scope for capital appreciation too.”
The Japanese bond market is excluded from most managers’ generalisations, as it continues to be beset by its very individual set of circumstances. Higgins says that because he and his team do not have strong convictions about the direction of the next move in JGB’s, they are happy to remain neutral. He adds: “We were overweight at one stage, but it has been a very tight trading range and we have moved back to neutral.”
JP Morgan on the other hand are happy to be bearish, on a 12-month view. Pegler explains: “If we have to own any JGB’s, we would favour the long maturities which, although under pressure from the economic recovery and the fiscal stimulus, should be supported as the Bank of Japan raises rates and causes the yield curve to flatten.”