The key issues facing bond markets by Vimal Gor, Head of Income and Fixed Interest, BTIM
In his June monthly newsletter, Vimal Gor from BT Investment Management outlines the key issues facing the bond market. BT is a top 3 performing Australian bond fund in our tables over the last 12 months.
The global reflation trade has no legs but the bond sell-off probably isn’t done
Inflation is starting to rise on the surface but the deflationary impact of China’s excess supply will continue to flow through the system. The perception that the Fed will raise rates this year and recent increased volatility will lead to a lower demand in bonds than seen in the past. Large global rate moves have seen huge changes in price relativities. For example, German Bund yields during March and April were trading at far less than half the average Japanese bond yield of approximately 0.35% and are now nearly trading at twice the current yield of 0.48%.
The FOMC doesn’t want to lift interest rates despite all the talk, but the picture is still good for US Dollar
The FOMC meeting in early June was a very important one as it was meant to be the meeting that the FOMC officially signalled that the first rate hike would be in September, ending a frustrating period of low volatility through the Federal Reserve’s desire to try and control the yields at every point of the yield curve with forward guidance. The outtake from the meeting was far more dovish than the market was expecting, with no explicit signalling of a rate hike, downgrades to growth and inflation, and a reduction in the fabled “dots” for 2016 and 2017. The Fed had given the green light for lower yields and steeper curves.
The pressure for rates to rise in the UK is increasing
There is one market where moves higher in yield have been somewhat justified by the underlying economic data: the UK. The improvement in unemployment has finally worked its way through to wage growth which is something the US data has struggled to show. This leaves the BoE in an interesting position. If the trends in wage growth and inflation continue, are they prepared to hike rates before the Fed does?
The RBA will (sadly) be swung towards staying on hold by a falling unemployment rate
While there has been a lot of concern over the (lack of) funding of the Australian Bureau of Statistics as a reason for the low quality of Australian employment statistics, the fact remains that the trend in the unemployment rate appears to have turned downwards after reaching a high of 6.4%. The improvement in the unemployment rate also matches up with a number of other employment series not calculated by the ABS that expected a turn earlier this year. The key data which we think the RBA should have reacted to earlier this year has continued to have gone unnoticed. Income growth is slower than it has been in 15 years and is still falling despite the improving employment statistics. Chinese easing hasn’t produced any dividends for bulk exporters as late 2015 prices for iron ore have once again slipped below the $50 a ton mark, placing pressure again on marginal producers. GDP growth forecasts will also continue to be downgraded by the Bank as the non-mining economy outside of residential construction shows little activity and exports slowdown from contributing a large amount to GDP. We worry that the RBA will ignore all of these other indicators of poor performance and focus on the unemployment rate. The question isn’t whether hikes aren’t even a consideration (if the Fed hikes this year it will be 6 years since they saw the peak in unemployment), but that they delay needed cuts for longer than necessary.
The full report can be read here.