World Government Bond Forecasts: Spain
World Government Bond Forecasts: Switzerland
World Government Bond Forecasts: Austria
World Government Bond Forecasts: Canada
World Government Bond Forecasts: Denmark
World Government Bond Forecasts: The Ecu
World Government Bond Forecasts: Germany
World Government Bond Forecasts: Italy
World Government Bond Forecasts: Greece
World Government Bond Forecasts: The Netherlands
The message is that some decoupling of European and US interest rates has been in progress, along with a convergence of yields within Europe itself.
Given its timing, the sudden break in the market in January had echoes of the early-1994 sell-off, prompting fears that history was about to repeat itself. But world bond markets were nowhere near as overbought as they were in early 1994. Then the average underweighted yield to maturity of the 21 bond markets included in Zurich Investment Management's database was barely 5.7%.
This January it was a full percentage point higher, yet inflation expectations were significantly lower than they had been two years earlier. The technical backdrop was also markedly different. The magnitude of the price collapse in early 1994 owed much to the role played by hedge funds and other highly leveraged investors.
A cheap money bubble was simply waiting to be pricked. Despite the availability, this time around, of plentiful Yen finance at 1% or less, its impact appears to have been minor. But what most distinguishes the price action over recent months is the marked divergence in the performance of the main markets, in contrast to the largely uniform collapse in prices witnessed in the first quarter of 1994, when the selling was more or less indiscriminate.
The worst performers have been New Zealand, the US and Australia, followed closely by the UK. By contrast, the strongest markets have been those of Spain, Portugal Switzerland and Italy, where, in some cases, the March/April rally more than restored the losses suffered in February. As it is, the average rise in yields across the 21 markets is just 40 basis points – hardly the stuff of which panic sell-offs are made.
In the process, European yield spreads over German Bunds have narrowed significantly – an example of convergence at work for which European government ministers would doubtless like to take some of the credit. Certainly, economic policy-making in these markets remains firmly focused on sound Maastricht principles.
But the reality is that markets have simply been adjusting to equilibrium values – and to the quite dramatic compression in the range of inflation expectations across Europe. On the fundamental valuation criteria employed by the ZIM bond valuation model, the premium status of Dm paper remains hard to justify.
The process of yield alignment in Europe has doubtless been aided by the weakness of the Deutschmark against the dollar, providing encouragement for funds to diversify out of Bunds and into other European government bonds. So where does the value lie now? Three markets appear particularly attractive: New Zealand, the UK and Australia.
The UK has been the poorest performer in Europe. Its political problems have been well chronicled but are probably discounted at current levels. Sterling does not look overvalued at present, government borrowing is on a downtrend (albeit a low one), and the long-term budgetary outlook is uncluttered by the big pensions overhang that clouds the outlook elsewhere in Europe. The bear case stresses the real possibility that UK fiscal policy could yet be subverted by political pressures ahead of the general election.
But were is this to happen, we could probably count on a swift correction from whichever party forms the next government. Australian and New Zealand government bonds have been caught in the backwash from the US market where the resilience of the economy has destroyed any consensus on the likely next move in short-term interest rates.
The result is that both markets now offer very high real returns. In Australia, long bonds offer yields of 9%, compared with inflation expectations of around 3.5%. This is in the context of a newly elected government keen to resist the wage push that was seen as inevitable under its predecessor.
In New Zealand, long-term yields, now at the same level as in Australia, contrast with inflation of just over 2%, and which the admirable Don Brash, the Reserve Bank Govenor, is intent on bringing back within a 2% ceiling. A strong currency provides added comfort. Outside these three markets, the ZIM model anticipates little or no capital appreciation in world bond markets on a six-month view. By and large, markets now look fair value and no more.
The message is that while the first half of the 1990s has been uncommonly kind to international bond portfolios p; producing double digit returns in four of the last five years – the second half is looking a tougher proposition. The process of adjusting to a low inflation environment has run its course: the challenge now will be to squeeze anything from the bulk of markets. Gordon Johns
World Government Bond Forecasts: Spain
World Government Bond Forecasts: Switzerland
World Government Bond Forecasts: Austria
World Government Bond Forecasts: Canada
World Government Bond Forecasts: Denmark
World Government Bond Forecasts: The Ecu
World Government Bond Forecasts: Germany
World Government Bond Forecasts: Italy
World Government Bond Forecasts: Greece
World Government Bond Forecasts: The Netherlands |