In bonds, the Market Climate last week was characterized by relatively neutral yield levels and slightly unfavorable yield pressures. Inflation shows no near-term likelihood of resurgence. Any sustained upward pressure on that front is most likely 3-4 years away, despite the enormous increase in the outstanding stock of U.S. government liabilities. Weakness in the exchange value of the U.S. dollar, however, is a more pertinent risk, and the risk of substantial deterioration is increasing, particularly in light of the recent softening in bond yields. We're not quite at the point where dollar weakness is an immediate concern, but from the perspective of fixed income, foreign currencies, and inflation risks, I would presently identify the dollar as our primary source of concern.
Bond bears beware. Benchmark government-debt yields in the U.S., Germany, the U.K. and Japan may fall during the rest of the year.
Stuart Thomson, a fund manager in Resolution Investment Management Ltd. in Glasgow, Scotland, said he remains bullish on major government-bond markets, even though they have underperformed riskier assets this year. The pace of global economic recovery likely isn't sustainable, he said.
Bond bulls argue that many investors will cut risky asset holdings and move money to government bonds in coming months, because stocks have become less attractive in the wake of the powerful rally since March.
Steven Major, global head of fixed-income research at HSBC Holdings in London, also warned against the risk of a scenario like that of Japan in the 1990s: Despite aggressive fiscal and monetary stimulus, government-bond yields there continued to fall.
At the beginning of the 1990s, the Japanese 10-year government yield peaked around 8%. After the credit and housing bubble burst, the yield slumped below 2% by early 2000. It then plunged to 0.5% in 2003 even as policymakers ramped up fiscal stimulus, flooded the banking system with money and kept the interest rates at ultra-low levels for an extended period.
"We have to watch this Japan experience," Mr. Major said. "This is not a traditional cyclical economic recovery right now."
And from Hugh Hendry in his August note to Eclectica participants.
But reassuringly the long end of the bond market has stopped registering new lows and this continues to be our largest risk exposure, representing 29% of the Fundís assets.
Jim 69 y/o
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