The all time low for UK gilt yields is being caused by a combination of quantitative easing and fear of European investment markets. With the US Federal Reserve announcing ‘unlimited’ QE until the US economy picks up and UK interest rates remaining at their all time low and further QE widely expected on this side of the Atlantic, three fixed income managers give their views of the short-term outlook.
Nick Gartside, international CIO for fixed income, J.P. Morgan Asset Management
“Well, was that it? The post ‘QE infinity’ rally seems to be consolidating already a mere two weeks after the big event. In reality though, this isn’t altogether surprising. As we discussed at the recent quarterly meeting the move from central banks acting in a reactive, to a proactive manner, and pledging to ‘do what it takes’ has reduced the tail risk scenarios. We reduced the probability of ‘crisis’ and ‘above trend growth’ to 5 per cent, whilst increasing our ‘sub trend’ recovery base case to 80 per cent leaving a 10 per cent weight on the ‘recession’ scenario. Essentially, this puts the market focus back to where it was at the turn of the year and attempting to read the tea leaves around two key issues: the growth outlook and the Eurozone.
“The growth outlook does look worrying, just as it has many times this year. Our proprietary lead indicators point to a very pedestrian growth profile and the anecdotal evidence from credit analysts suggests increased nervousness from company management teams. Recent rhetoric, and actions, from central banks, however, reinforces that they are alert to downside risks and stand ready to provide more monetary policy accommodation.
“Looking at the other pillar of worry, the Eurozone, there’s no cogent message from the tea leaves. We’re back to trying to decipher summit communiqués as well as conflicting and competing versions of events from national policymakers. The focus now is on the implementation risk. When will the fiscal compact be implemented? When will the plans for a banking union be advanced? And above all, when will the weaker Eurozone countries move to request ECB assistance? The tea leaves are sadly unclear on all of these.
“For fixed income markets this means a renewed focus on policymaker action (and inaction) which will fuel the usual risk on: risk off cycle and in turn create opportunity. With the central bank put option in play, interest rates on hold for longer and cash cascading into bond funds, we’re also inclined to look to buy corrections in risk assets.”
Chris Iggo, chief investment offier for fixed income, Axa Investment Managers
“The decision to invest in corporate bonds or government bonds is driven by whether the difference in yield between the two assets is perceived as being enough to compensate the investor for taking on the additional credit risk that comes with corporate bonds relative to government bonds.
“In days gone by it used to be the case that government bonds were seen as risk free and would provide a return somewhere close to the expected long-term growth rate of the economy in real terms. Corporate bonds were seen as riskier because companies, if they got into financial difficulties, might not be able to pay their coupons or, in the extreme, might even default on their debt.
“Today, things are somewhat different. The risk-free nature of government bonds has been brought into question by the sovereign debt crisis and the general growth in indebtedness of governments around the world. And at the same time, the financial repression represented by QE has driven yields down to levels that don’t offer a return commensurate with potential economic growth.
“In short, QE and fiscal chaos is crowding investors out of government bond markets with the public sector absorbing more and more of government debt either as a result of monetary reflation (central bank financing of governments) or emergency funding (public mutualisation of government debt in Europe).”
Steve Brann, manager, Apollo Multi-Asset Cautious fund
“One particular asset class we are extremely wary of are gilts. Last year this meant that we did not participate in some of the most spectacular gains, but to our minds these were almost entirely based on the desire of investors for lower risk assets and continued ‘flights to quality’ in the face of global economic uncertainty. Certainly, such returns would rarely be expected from an asset which has been regarded traditionally as fairly dull and low risk.
“It is quite clear to us that the majority of world governments are trying to avoid, at all costs, the type deflationary cycle that existed in the 1930’s as the world de-levers. The introduction of QE packages are designed to ease the debt mountain with a healthy degree of inflation which is essentially a secret tax on the consumer eroding the real value of the debt.
“Despite the fact that the markets have believed in the ‘silver bullet’ from Marion Draghi, it would appear that much of what has been promised is already unravelling. With a Northern European pushback from the ‘unconditionality’ elements of the agreement and riots in the street in Greece and Spain over austerity we are far from out of the woods.
“The current asset allocation at Apollo would conclude that we neither believe in the second Great Depression outlook of gilts or the optimism of the equity markets that Europe and the over-leveraged have the ‘silver bullet’ to solve their problems. The reality is that we are faced with difficult times and de-leveraging through austerity or inflation will be a long and painful experience. Our asset allocation reflects this as we do not hold any gilts and our equity allocations are at the lower end of our trading bands.”