As we enter September, volatility remains; Japanese stocks closed the first day of the month down a further 3.84% sparking further selling in the European bourses. At the time of writing the FTSE is down 2.50%, the DAX 2.83% and the CAC 2.62%. However, sovereign bond markets, which usually benefit as a safe haven, are not seeing as much buying as one would have thought. The UK is an outperformer with ten-year yield falling 4.6 basis points, which is more to do with the release of a weaker manufacturing PMI this morning than anything else, German Bunds only off 1 basis point and French bonds down 0.7 of a basis point. You would have thought with stocks seeing red across the board, investors would be moving heavily into these assets. So why are we seeing a lacklustre performance from bond markets?
We feel this is due to the overly optimistic outlook priced into stock markets, while bonds seem to be rather more finely priced given the global economic outlook and the risks for a further fall in inflation as Asian exporters start to export deflation across the developed world.
Our own models suggest a more sanguine outlook in terms of world growth than stocks have priced in and our inflation models continue to signal further downside risks to inflation forecasts. But bond markets with historically low yields may need to see further evidence of this before attacking the lows in yields seen back in the first quarter of this year.
Our strategy has been to remain invested in better quality credits with a longer maturity than our peers thereby avoiding, as much as possible, the volatility associated with the repricing of stock markets and credits. With the strong possibility of a Fed rate hike this month, especially if we see a stronger nonfarm payrolls release this coming Friday, we believe being invested in lesser credits that have short-dated debt to roll during a period of Federal Reserve normalisation of the funds rate is exactly the wrong positioning for funds.
We do see one or maybe two moves from the Fed pushing up the funds rate to closer to a 0.5% to 0.75% range before the committee sits back and watches data for a while. Although the economy has added quite nicely to employment over the last year or so, one of their main targets, inflation or the lack thereof will curtail further economic performance and will fail to reach the Fed's 2% target over the next few years.
Volatility, as seen in August, will have been noticed by the Fed but the need to move off from zero rates, we think, is strong while they seem to have US economic growth above the 2% per annum level.