Healthy environment for global bonds
21 November 2006
With central banks around the world focusing on controlling inflation, and economic growth likely to be more moderate than in recent years, expectations are that global bond markets will generate modest returns over the next 12 months, according to Fidelity International.
Ian Spreadbury, Fixed Income Portfolio Manager comments: “In the US, the Federal Reserve’s decision to leave interest rates unchanged in August - after raising borrowing costs 17 consecutive times - suggested to some investors that the current tightening cycle had come to an end. With concerns over the state of the economy, consensus expectations are for rate cuts to come through early next year, which should heighten the appeal of fixed-income assets.
“The Japanese economy is probably the most susceptible to a slow down in US economic growth. Following an announcement in the first quarter of this year, the Bank of Japan officially ended its zero-interest rate policy with a 0.25 per cent interest rate increase in July. Any further tightening of monetary policy would be a delicate process following such an extended period of deflation in Japan. Current expectations are for another 0.25 per cent rise by early next year end but that will depend on any downturn in the US and its impact on the local export market.
“Closer to home, expectations are for the European Central Bank to raise rates once more before the end of the year to 3.5 per cent and then pause at 3.75 per cent during the first quarter of 2007. However, bond markets in the eurozone have been driven higher recently, as expectations for additional hikes have been scaled back amid signs of easing growth and slowing inflation in the region.
”In the UK, stable economic growth and contained inflation should continue to provide support to UK Government Bonds. The Bank of England lifted interest rates by 0.25 per cent to a five-year high of 5 per cent earlier this month, following evidence of stronger economic growth and expectations of rising inflation leading investors to expect one more rate increase next year. However, rises may be capped by the outlook for global growth amid an economic slowdown in the US.
Mr Spreadbury concludes: ”While the last 12 months has been a challenging time for global bond investors, the outlook for 2007 is positive. A gradual slow down in global economic growth and a focus from central banks to control inflation should buoy markets over the next year. Although credit fundamentals remain strong, I expect some deterioration to come through during 2007, but with a marginal rather than a wholesale weakening of the corporate environment. This could lead to a pick-up in default rates, although it is important to note that this would be from low levels. While yield spreads on corporate bonds remain at tight levels, there are still plenty of attractive opportunities within the corporate markets to pick up decent value relative to government bonds.”
