World Government Bond Forecasts: Germany

Calm after the stormThe recent drop in bond prices has been reminiscent of 1994 when investors were caught off-guard by a year-long bear market. Although there are parallels in valuations and investor structure, inflation rates and money market rates are much lower than two years ago and there is still scope for Fed easing, while prior to the 1994 bond crash the Fed had signalled rising interest rates.

The yield curve, which in 1994 had been inverted up to about 3 years, is very steep, and investors generally are less exposed than in 1994. Against this background, we see German bonds at the beginning of a fairly calm period. Yields temporarily have matched our year-end forecasts; thus we expect volatility around present levels but with no clear cut trend for the remainder of this year.

We forecast money market rates to remain nearly static around current levels and 10-year bond yields to be range-bound between 6% and 7%; there will be only moderate yield rises in 1997. In the year ahead, it is not so much directional views that will be rewarded, but riding the curve and the adept exploitation of the fluctuations in yields, the yield curve shape and sector spreads.