Standard Life: Diverging signals in fixed income

Philip Laing, investment director, Government Bonds at Standard Life Investments comments on the outlook for yield with global bond markets being priced for perfection.

Mixed signals from the Fed
2015 has proved to be a year of chopping and changing  across global bond markets as the impatient spotlight of investor attention has flitted between different factors.
No sooner had the all-encompassing risk of Grexit been messily averted than the disinflationary breeze again blew in from China. The nervousness of Asian and emerging market equities has rippled back into western economies, triggering a general loss of confidence and a shift into safe haven assets such as bonds.

For US bond investors in particular this has proved an awkward period. They have been faced with mixed signals: a generally benign domestic recovery, a subdued short-term inflationary backdrop and the possibility of a rise in interest rates in coming months if the labour market tightened enough. Recently, the situation has become even more complicated. The communique explaining the recent Federal Reserve (Fed) decision not to raise interest rates may mark a significant and potentially confusing shift.

A somewhat blinkered domestic agenda is now more marginalised by a much broader global economic focus. In effect, an explicit link to Chinese activity, and an unwillingness to express any degree of confidence that inflation would return to the 2% objective, has layered an extra degree of uncertainty onto policy change. The latter not only contrasts notably with Vice Chair Fischer’s early vigilance message at the Jackson Hole conference but also leaves limited credible scope for a radical
rethink in the short term, even if an upward move on rates in 2015 is still being outlined as the majority expectation by FOMC members.

Fed Chair Janet Yellen may well be attempting to steer a ‘vigilant’ path of letting the economy run hot. ‘Global developments’, a strong dollar and downward pressure on
goods price inflation are understandable camouflage to allow the Fed Chair to get a splintered committee to follow her lead. Conversely, a resilient surge in wages or employment cost data could quickly see such external concerns abandoned. This could well be a game of convenience.

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