Bond Outlook May 31st

The high volatility in equity markets, and a strong possibility that they are entering a bear phase is making investors reconsider the overall mix of their portfolios. In principle, bonds should be benefiting from their low-risk nature, and, indeed, on down days for equities, bond yields tend to rise. However, the fact that inflation and rising interest rates are bad for both stocks and bonds, has led many of our clients to hold more cash. As they wait to reinvest, we would hope they see the advantage of fixed income: high-credit bonds of relatively short duration, and floating rate notes. Risk premiums are narrowing as risk aversion increases, so that recommendation is “rather obvious”.

Of greater interest to our readers should be where they might find interesting ideas within fixed income. We address this theme beginning from our views on macro-economic developments:

• the weak USD and a shift in consumption to the rest of the world
• default rates and credit spreads at an all-time low (they can but rise)
• emerging currencies very volatile, with most of 2005 gains wiped out.