The last month has seen an immense rally in government bonds, predominantly spurred by Alan Greenspan’s comments. His hints at concerns of deflation in the US have given the market the impression that an increase in interest rates by the Fed will be a long time coming. Economic data released over the past month has only underpinned this view, and Wim Duisenberg’s hawkish comments have been forgotten. Investors which had changed their bets from a 50bp cut to a 25bp cut from the European Central Bank have reversed their opinions, and now sentiment points to cuts of at least a half point over the rest of the year.
This rapid turnabout has opened up the short-end of the euro government curve where fixed income managers still see value. While the value in the two-year will not be long lived, at present the market has yet to price in the larger rate cuts expected.
On a short-term basis, treasuries are attracting the most attention, but as says Cerys Williams, head of fixed income at Morley Fund Management in London, six to 12 months the view is more positive on Europe.
Paul Skinner, product specialist in fixed income in London at Gartmore, is more positive in European government bonds, than in gilts and treasuries. Skinner believes there may well be an interest rate cut in the UK. This would not be beneficial for the long end of the sterling yield curve, and Gartmore is underweight there, and overweight on shorter maturities. In treasuries, Skinner says the story is similar and Gartmore has moved out of US government debt into Europe.
Rajeev de Mello, senior investment manager at, Pictet Asset Management in Geneva highlights which areas of the curve he is focusing on at the moment. “The middle has seen significant outperformance and we have now reached very low yield levels in this area of the curve. We have bought the long-end and two-years and have sold the middle maturities.” Williams agrees that the middle of the curve offers less value than the short and long ends.
The corporate bond market is proving a little trickier to judge. The last six months have seen an amazing run. For Skinner, this means time to take profits on trading positions. “In some areas pricing is stupidly expensive. Things have moved a long way quickly, and locking in profits now is beneficial.”
“There is still value in some of the higher beta names – the Triple B credits – and those credits could still run, but it is very name specific,” says Skinner.
Guillaime Bucaille also of Pictet on corporate bond side, agrees that stock-picking is core at the moment, and choice is based on macro-economic issues. Deleveraging has been a continued theme over the last six to 12 months, but with such a sluggish growth rate and weakness building up in the economies, Bucaille questions whether issuers will make it through.
“If a company cannot generate enough cash flow, it will have to look to other means of raising money, and the corporate bond market is divided into two camps. Issuers which will make it, and those which will need to raise money through equity or convertible bonds.
“For these latter companies, any volatility in equity markets will affect the volatility of credit spreads. The more vulnerable credits could therefore get worse if we run into deflation or if the equity market performs badly,” says Bucaille, highlighting autos and industrials as sectors in this area.
For those sectors like telecoms which have avoided turning to raising cash through there is not much potential left, as a rally has already taken place for the best credits. Pierre Py, head of credit bond research at Credit Agricole Asset Management in Paris agrees. “The liability story, that of the telcos, has moved to a growth-related story. The key issues now are specific stories and sectorial issues.”
“We have been massively overweight in telcos, but after such spread tightening we have eased somewhat. In a few names, there is something of a bubble. And we are concerned about autos – especially US autos – a growth-related sector.”
Williams agrees that caution is necessary. “We are modestly overweight in corporates. But are becoming more cautious as markets have come a long way. We don’t intend to move out of credits in the short term, but stock selection is crucial. We are very mindful of potential pitfalls.”