Looking ahead in the bond markets
Concerns regarding European government debt
are set to continue, as are the worries over bank solvency. Slowing
GDP in developed markets and rate hikes in developing nation states
add up to a strong set of headwinds for bond investors. The
commercial bank stress tests are the near-term focus for
commentators, although there has been disquiet expressed from some
quarters that the tests will be ‘un-stressful’. The hope is,
subject to the reports published, this process will positively
impact sentiment in much the same way the stress tests created a
step-change in mood when the results were published for US banks in
2009.
The slow down inferred by economic data is
clearly focusing the minds of investors and policy makers alike and
data releases will be scrutinised intently. The
rhetoric delivered by central bankers in response to
these releases is likely to drive asset prices, more so than
corporate earnings news, which we expect to remain positive.
Analysts continue to highlight the possibility of further
stimulus to re-ignite stagnating economies and we need to remain
alert to central bank action.
As always, it is important to be alive to
surprises on the upside and if the double-dip scenario does not
manifest itself, corporate credit is expected to provide attractive
investment returns relative to other asset classes. Moreover, the
fundamentals in a number of developing nations’ debt markets are
very attractive, particularly when compared to those across the
markets of many Western nations. Therefore, opportunities will
present themselves and we believe diligent investors will be able
to capture returns from the bond arena.
The one issue we have not discussed in any
detail so far is the question of inflation or deflation. Securing
cash flows in a potentially deflationary environment has
undoubtedly been a major driver behind capital allocation to fixed
income securities and it is a theme to which we subscribe. Capacity
under-utilisation in the global economy is often cited as a reason
to remain unconcerned about inflationary pressures and this has
developed into the consensus view. Disposable household income,
particularly in the US, is low by mid-cycle standards and inflation
driven by wage growth would seem to be some way off. What if,
however, economic data does rebound or inflation does begin to be
exported from China, where wage growth is accelerating very
dramatically? What if a monetary inflation, caused by substantial
quantitative easing, takes hold earlier than expected? A
realisation inflation is being underestimated would create a
powerful market reaction and we, as wealth managers, have started
to think about this ‘what-if’ scenario.