Bond
Outlook [by bridport
& cie, September 3rd 2003]
The sense of hiatus to which we alluded last week remains,
particularly as to whether or not bond yields will break out on the
upside. To give you our conclusion first, it means that we can make no
recommendation yet to lengthening in the Western currencies, but we shall
discuss below some considerations on yield curves' shape.
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One of those considerations is the Japanese yield curve, a topic we
rarely comment on, but which has a major impact on Western financial
markets. The improved attractiveness of JGBs, the ten-year yields of which
have increased since June this year from 0.45% to 1.65%, understandably
deflects Japanese demand from foreign bonds to domestic. The effect is
then paradoxically multiplied by the very volatility in JGB prices
(increased domestic risk means reducing exposure to foreign currency
risk). Recently we have pointed out that the US deficit is being financed
by both Japan and China taking up US Treasury bond issues, and questioned
how long their respective Governments can and wish to keep up this effort.
In Japan, it must be a case of the public authorities moving against the
flow of private domestic and foreign capital. Currently this phenomenon is
affecting the euro before the dollar, but the key point is that the yen is
again under great upward pressure. |
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China, too, is under considerable pressure to revalue, with both
the Chinese Government and the forward market of the renminbi signalling
that there will be at least some modest concession to that pressure. The
USA is therefore in the extraordinary situation of being dependent on
these two great trade rivals for the maintenance of its currency - a sword
of Damocles which the Democrats will surely point out, perhaps adopting
the jibe found in the FT that Bush is the "Manchurian candidate for
re-election". |
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The US recovery now underway is lukewarm because of the
spare capacity and continually increasing unemployment, constrained
by its dependency on cheap money, and fragile because of its
dependency on foreigners' good pleasure. Nevertheless, markets clearly
perceive the recovery as sustainable, pushing up bond yields and
stock prices. So long as they hold that belief, the risk on bond yields is
biased towards the upside. This is true of Europe also, where despite
every attempt by France to work (or rather not work - remember the 35
hours week) itself into a recession, the economic signs in Germany are not
so bad at all; even Business Week thinks it! |
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Upward market pressure on yields purely from an economic recovery
would be very welcome. It is the second pressure, Government borrowing,
which is the barrier to sustainable expansion. Both these pressures,
present on the entire 1-10 year range of the yield curve, imply a still
sharper rise in the money-market part of the curve (as Central Banks
anchor the overnight rates at "unnaturally" low levels). The entire bond
portion of the curve is therefore flattening, led by the short end. The
third source of upward pressure, the latent risk of inflation from a weak
dollar and higher commodity prices has not yet, however, made itself felt
at longer maturities. |
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Emerging markets have been increasingly popular among bond
investors. They have given a relatively safe means of obtaining
respectable yields in a low-yield environment. Many of our clients are now
taking profits on this part of their portfolio, particularly in those
markets that might be called "newly-emerged" (Asia) rather than those
"still emerging". Their attention is switching to countries for which the
word "emerging" still applies reasonably well, but probably not for much
longer, such as Russia, Turkey and Brazil. |
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The Swedes are very likely to vote "NO" to the euro. The Growth and
Stability Pact is being treated with the contempt it deserves. It is
inconceivable that the UK public come round to favouring the euro so long
as the UK economy steers this quite clever route between the USA and
Euroland. Nevertheless, the euro is still becoming a secondary reserve
currency (which is not all to the good as its value may be too high for
industry). The change of ECB Governor will be an interesting tale to
watch. |
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Recommended average maturity for bonds in each currency
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Stay short until intermediate yields have met clear resistance, or
broken out to new sustainable levels. |
Currency: |
USD
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GBP
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EUR
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CHF
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As of
30.07.03 |
2006
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2006
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2006
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2006
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