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2017 set to be another roller-coaster year for bonds: Schroders


2017 is set to be another roller-coaster year for bonds, says Schroder Investment Management in Singapore (Schroders). And it intends to adopt "a more opportunistic investment strategy" to cope with this.

Bob Jolly, head of Global Macro Strategy at Schroders, says in his outlook for global bonds next year that the uncertainties and challenges which have plagued the market this year will remain. "2016 looks like a year for the history books. Will we ever again see so many of the world's government bonds offering negative nominal yields?"

Yet, he adds, the world remains far from fixed and considerable uncertainties remain. "These include what the UK government's strategy is on Brexit, a high degree of uncertainty about just how far the rise in populism will run in Europe and most recently what exactly President-elect Donald Trump's plans are for his trading relationship with the rest of the world."

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Mr Jolly expects another rollercoaster year for bonds and foreign exchange, based on conclusions drawn from a strategic analysis of economics, politics and what markets currently discount.

For a start, he says, central banks around the world have underestimated the reticence of consumers (both household and business) to use the additional windfall from lower mortgage and interest costs - as a result of lower official interest rates and ever-increasing amounts of quantitative easing (QE) - to go out and spend or invest. Government spending then had to become the necessary bridge between consumer demand and potential supply, with central banks increasingly saying that governments need to stimulate their economies through fiscal policy.

"However, global debt may have become cheaper to finance but the amount outstanding remains prohibitively high to allow a fiscal bazooka.

"We will no doubt see some of the heavy lifting done via government spending but a bazooka, given the fiscal dynamics, seems wide of the mark, even in the US," he says.

Structural issues also persist. The pace of structural reform in Europe has slowed to a crawl, Mr Jolly notes, and the UK seems to be struggling to find a palatable negotiating strategy for a post-European Union (EU) world; Japan, meanwhile, remains stuck in a low growth-low inflation setting. Emerging economies have also been unable to find a replacement engine, now that China's growth has slowed.

So, while bond yields may continue to creep higher as central banks attempt to wean economies off QE and record low interest rates, it may be far too premature for them to normalise policy.

"What we are currently seeing is a cyclical upswing clearly assisted by easy monetary policy and a bit of a fiscal shot in the collective arm which may continue to tame yields.

"However, central banks will be cautious about removing policy accommodation prematurely and are more likely to take greater inflation risks which, rightly or wrongly, they believe they can bring back under control."

Against this backdrop, the Schroders analyst believes one needs to stay active and grab the opportunities as they come. For example, he believes break-even inflation - the difference between the yield of a regular government bond and an inflation-linked bond of the same maturity - which has moved higher post-Trump's victory still has room to move higher, especially if the President-elect becomes more protectionist.

"The US dollar probably has room to move a little higher but here we need to be increasingly selective on whether we express a bullish US economic view through the US currency or a more defensive stance towards US government bonds (duration). The two are clearly linked."

As for corporate bonds, the potential change in tax structure suggests that American companies may actually shy away from debt financing, which would be good for investors in both investment grade and high yield or non-investment grade corporate bonds.

He also expects greater economic divergence between the world's major developed economies and, within the developing world, clear divergence between those that find a revised business model and those that do not. "While we are unlikely to see a return to the extreme negative real and nominal yields seen over the summer, it's also unlikely we will see the yields investors became accustomed to before the great financial crisis began all those years ago.

"The roller coaster is alive and kicking. For an active fund manager, it will be an interesting but potentially rewarding ride."