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Multi-asset view: Government bonds remain under pressure

niven

Recent market confidence has been supported by evidence that the harsher fiscal regime is having a milder impact on the US economy than had been feared.

The growth in employment has been better than expected, leading us to believe the world’s biggest economy is starting to respond to the billions of dollars of stimulus that have been pumped into it.

We believe the effects of a number of positive factors, including housing, energy and net wealth, will strengthen in the second half of the year and into 2014 and have raised our position in US equities to neutral from underweight.

In Europe, the consensus expects growth to contract further, despite the smattering of positive economic surprises in recent weeks. Car sales in particular have been weak and this will put pressure on industrial production data for the first and second quarters.

In emerging markets, uncertainty about China’s prospects in the second half of the year underlies our cautious stance. There is an expectation for growth to decelerate and we fear monetary tightening could be implemented to tackle higher inflation.

In addition, the strengthening dollar and weakening yen are pressuring emerging economies.
Our highest conviction is currently Japan. The reflationary policies of recently elected prime minister Shinzo Abe have been well received and the new Bank of Japan governor has shown himself to be even more dovish on policy than was previously hoped.

Consensus forecasts for growth in 2013 are finally rising strongly and we expect further fiscal stimulus and the tailwind of a weaker yen to drive a GDP expansion of about 2 per cent over the year. The market may look overbought at present but we feel there are catalysts for further progress.

Overall, the themes that threatened risk markets last year are abating, so we are retaining our overweight position in equities.

By contrast, Government bond prices are likely to remain under pressure, with yields edging higher as rising energy costs feed through to inflation. We have thus taken a more negative stance and increased our underweighting.

For credit, spreads may be tight but they have some scope to contract further in higher-yielding areas, given the improving US housing market and the promise of less financial stress in the eurozone. We have upped our exposure, preferring emerging market debt and high yield over investment grade.

Our preference for risk assets acknowledges the potential for rising volatility. Monetary policy surprises, geopolitical events in Asia and the Middle East and the omnipresent eurozone crisis are factors that could reverse the gains seen so far this year.

The lack of value in mainstream Government bond markets forces our hand to a degree but, overall, our analysis points to an improving environment for equities.

Paul Niven is head of multi-asset investment at F&C

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