A little more conversation, a little less action
Q: Has the increase in government bond yields had an impact on investor behaviour in recent months?
A: As 10-year rates rise, pension fund deficits get lower as you’re discounting their future liabilities at a higher interest rate. This may make them more risk-seeking as those that had small deficits may find themselves with a surplus they could use to see incremental returns.
Corporate credit has sold off over the last couple of months, but a big chunk of that is just duration. There’s not been much of an implication for corporate credit from government debt yield increases.
Q: What does the fact that bond yields have held up at a higher level suggest about market expectations?
A: I don’t know if you are really going to get higher rates at the front end, they’re really just talking about tapering quantitative easing. The BoE and ECB have both explicitly stated that they’re going to hold rates down for longer than the market was expecting, so the focus will be very much on the messages coming out of the Fed. You’ve seen the 10-year yield rise much more than on shorter duration bonds reflecting the fact that people don’t expect a sudden rate hike.
We’re still short French government bonds but have closed our short German bunds. That made us some money but the US and the UK would have made for better shorts over that time. But the key factor now is that our currency positions are starting to work as the dollar’s strengthening and the euro is getting weaker, which is exactly what the eurozone needs for the periphery to return to competitiveness.
This is being helped by the apparent divergence in messages from the central banks. The Fed is discussing tapering while the ECB pledges to hold down rates for longer.
Q: Has news of weakening in some key emerging economies shifted your view of global growth prospects?
A: Although global growth is still around its long term average, I think we’ve seen a bit of a rebalancing of where it is coming from. In aggregate it’s about the same as where we were a few months ago but you’ve seen a shift where emerging markets have slowed and the developed world, particularly the US, has improved slightly.
That said inflation has been pretty much falling everywhere, with the UK the one exception. Everywhere else, including emerging markets, you’ve seen it ticking down over recent months.
I do think it is really just talk from the Fed and they won’t be tapering any time soon. Neither the pace of jobs growth nor persistent low inflation seem to warrant tapering right now. They were clearly worried about asset bubbles as there was this perception of a central bank “put option” but I don’t see why they would be slowing their monetary stimulus. I don’t think the recovery is self-sustaining yet.
Q: Is the portfolio balance effect of quantitative easing being constrained by low inflation expectations?
A: When there’s no inflation you don’t have to take a risk to keep up with it. That is the environment that people might be feeling we’re in.
I do think that there will be inflationary pressures towards the end of the decade but there’s absolutely no sign of them right now.