Year of post-Y2K ‘unwinding’
Official rate rises have already been announced, and so soon after the festive season, the Bank of England leading the way with its widely predicted quarter- point rise on January 12. Market participants also expect the Federal Reserve to jump in and raise Fed funds again, or rather carefully step, as it would be surprising to see Fed chairman Alan Greenspan associated with any ‘irrational’ leaping. Another quarter-point rise is already priced into the market, and further small rises are predicted for later on in the year.
For some fund managers, the gradualist approach may in the end prove uncomfortably unsatisfactory for Treasuries, and bond yields could be about to rise quite sharply. Rod Davidson at Murray Johnstone is definitely in the bear camp, and points some of the blame at Greenspan. He goes on, “Although it’s fair to say that the consensus on the US bond market is already quite bearish, we think things could get a lot worse as Greenspan disappoints the bond market with his apparent reluctance to really have a go at reining back the charging US economy.”
Davidson believes that there will be a good deal of Y2K ‘unwinding’, and that many companies will try and make up for, in effect, lost time at the end of last year when many projects were put on hold as the new year approached. He forecasts there could be an extra surge in investment spending in the first quarter that many investors have not factored into their GDP numbers for 2000, which could easily shock the bond market .
Norman McChesney, senior fund manager at Aberdeen Asset Management, agrees that the US economy will be the wild card in both bond and currency forecasting. He argues: “One of the main factors behind the battering the euro took last year was the dramatic difference in growth rates of the US and sickly Euroland. Now at the start of this year, we are at last seeing growth picking up in Europe, and most importantly in Germany, the heart of Euroland.”
McChesney makes the point that, while interest rates will continue to rise in the US and look set to do the same in Euroland, because the US is so far ahead in terms of the economic cycle, then the Fed’s rate hikes will have a faster effect on the US economy.
He adds: “The euro’s technical situation is much stronger now than it was a year ago, indeed part of the reason for the currency’s sustained weakness was down to the unwinding of so many speculative euro-bull positions. Couple that with a more experienced and “wordly-wise” ECB council – who made several gaffs on the verbal intervention front over 1999 - and the euro should be stronger than the dollar this year, but I would have to say that our bullish euro forecasts are vitally dependent on the timing of the downturn in the vigorous US economy.’
Although the managers at Murray Johnstone have already positioned their funds long the euro, Davidson suggests that the ongoing strength of the US economic expansion will preclude any rally by the Euro until the second half of the year. “We do not see how the euro can rally versus the dollar just yet,” he says, “and would not be surprised to see a bout of further weakness in the near term. If the consensus is for a stronger euro, then that makes us more convinced that the euro has a few more difficult months ahead. And we do not see the currency getting back to where it was on launch day, not this year at least. I would add, however, that we will be trading the euro from overweight given our long-term negative views on the dollar.”
Having been part of that small group of investors that correctly forecast the euro’s weakness in 1999, JP Morgan’s currency management team has now shifted its euro exposure much closer to neutral. Head of the team, managing director Harriett Richmond, explains, “The euro has fallen substantially and we believe we have already seen the majority of its decline. However, although we also believe that the currency is now looking pretty cheap values, we cannot rule out further erosion, perhaps to as low as 0.95/0.97. As things stand at the start of the new year, there are still many negatives for the euro, both technical and economic. And the interest rate attractiveness of the US dollar has certainly not gone away.”
Although not overweight the euro, Richmond and her team believe that the currency’s cheapness will bring in buyers in the end, and that the strength of the US economy and the three quarter- point rate rises from the Fed which surprised so many investors and were so supportive of the dollar throughout most of 1999 are now behind us and that the economic and interest rate backdrop will turn more and more in favour of the euro in 2000.