A cagey US Federal Reserve and unfinished business in Greece will likely continue to unsettle the credit markets, but Australian government bonds may offer one route to mitigate risk, and select opportunities exist in countries such as Cyprus and India, according to Ariel Bezalel, manager of the Jupiter Strategic Bond Fund.
The hardening of Fed rhetoric around the provision of guidance has added to general nervousness around the outlook for US monetary policy, and this has proved a headache for bond markets. As a result, the risk of a policy error, in our view, has increased.
That said, we do not see the possibility of a rate hike as early as September as a sell signal for bonds. We think global growth and inflation are likely to be capped in an environment where high debt levels and ageing populations in much of the developed world are likely to continue to act as a large impediment to economic growth. In addition, in the US, there are many signs of ‘good deflation’ such as more efficient business processes that have been keeping a lid on inflation pressures. In this context, we don’t think the global economy would be able to handle markedly higher rates and expect any tightening of global monetary conditions to be gradual.
In this context, we continue to retain a bullish view towards the US dollar.
Greece saga taking time to play out
The Greek saga meanwhile will continue to dominate headlines and induce bouts of volatility in credit and peripheral sovereign debt. We believe that there will probably be further flashpoints between Greece and its creditors in the months ahead. We therefore took profits on our Greek government bond position prior to the Greek parliamentary vote on July 15th. Ultimately, our belief is that at less than 2% of European GDP and with much of Greece’s debt held by the public sector, the fallout in the event of “Grexit” is unlikely to be a Lehman moment.
A sell-off in peripheral government bonds (such as in Spain, Italy and Portugal) could lead to more aggressive intervention by the European Central Bank (ECB) to keep a ceiling on yields. Given this, we believe having a large weighting in medium and long-dated triple ‘A’ rated government bonds, with the aim of mitigating deflationary tail risks is a sensible route for us to take.