As 1999 drew to a close, the US economy had begun to resemble a runaway train. The firebox had been ...
As 1999 drew to a close, the US economy had begun to resemble a runaway train. The firebox had been stoked by the ebullient consumer, as greater personal wealth led to a spend, spend, spend mentality.
Despite rampant growth of the US economy, inflation remained a spectral presence last year. Many analysts were quick to invoke the new paradigm, that technology-led increases in productivity have upped the rate at which an economy can grow without causing higher inflation, as the reason for this golden economic scenario. What is this new safe rate? The jury is still out.
As the record breaking economic expansion rumbled onwards, US Federal Reserve chairman Alan Greenspan had one hand on the brake lever to try to ensure the train remained on track. Rates were eased upwards from 4.75% in June to 5.5% by Millennium Eve, causing the US bond market to lose ground steadily. Most other global bond markets followed suit.
US bonds rallied in early 2000 as further interest rate rises resulted in growing confidence that Greenspan's work was nearing completion. Unfortunately the rally has proved a touch premature, as a higher than expected 0.7% advance in consumer prices during March has forced bonds on to the back foot. We expect US bonds to remain under pressure in the near term but should be able to advance later this year.
The Euroland and UK bond markets are likely to be heavily influenced by events Stateside, although superior inflation outlooks underpin both. Euroland battled its way out of recession in 1999 to enter a phase of economic expansion, as low interest rates and the weak euro enabled exporters to take full advantage of the upturn in global demand. The high level of unemployment provided plenty of spare economic capacity to enjoy stronger growth without causing significant inflation. As a result, the European Central Bank (ECB) has been able to nudge interest rates up towards a more neutral level. This solid fundamental backdrop means that Euroland offers one of the world's more attractive bond markets.
In the UK, Chancellor Brown has presided over robust economic growth allied to record low inflation. Growth now appears to be coming off the boil, and bond investors are hopeful that the peak in interest rates is just round the corner. While the expected weakness in US bonds is likely to keep the UK market in check in the near term, a prolonged rally later in the year looks on the cards.
The one major bond market that continues to pay little heed to events elsewhere remains Japan. Interest rates have been kept close to zero as the economy has clawed its way out of a deep and long-run recession. Rates will begin to rise later in 2000 as recovery beds in, at which point we believe Japanese bonds will break out of their tight trading range and lose ground sharply.
Martin Hall is head of fixed income at Norwich Union Investment Management Limited