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Further rise in bond yields expected Back  
Bond yields look set to rise into 2004, but will fall soon after.
Dan McLaughlin
The rate cycle has turned, with the sell-off in bonds testimony to the markets belief that the next move in official interest rates will be up. In the short term this implies further curve steepening, and I expect 10 year US yields to reach 5 per cent by year end, on the basis that real growth will be stronger, so pushing up real bond yields. Central Banks will begin to tighten policy next spring and this will prompt curve flattening albeit initially against higher longer dated yields.

Alan McQuaid
The sell-off in global bond markets over the past eight weeks is the sharpest since the bond bear market in 1994, although it should now start to pause. The rise in yields puts bond markets back in touch with economic reality. The cyclical outlook for bonds is bearish in all major markets even if growth remains below the standard for historical recoveries. Bonds are at even greater risk if a synchronized global economic recovery proves stronger than currently anticipated, which is a distinct possibility. Moreover, fiscal conditions are deteriorating in most major economies, which signal that bond issuance will trend higher, adding to upward pressure on yields.

The improving world economic outlook is bearish for government bonds. Deteriorating fiscal positions will add to upward pressure on bond yields. The Treasury bubble has burst, and the market looks oversold in the near-run. However, overall, the cyclical outlook is negative. Eurozone government bond yields have cyclical and intermediate-term upside, although range-trading is likely in the near-term. On a 6-month view, I would expect German bunds to out-perform USS Treasuries. But in the latter part of 2004 when bonds have reached fair value, the US presidential election is out of the way, fiscal reflation has ended and the American economy is running at full steam, bonds should come back into favour with the US out-performing the Eurozone.

Oliver Mangan, chief bond economist, AIB Group Treasury
Bond yields have risen sharply since the middle of June. This partly represents a market correction as yields had fallen to exceptionally low levels. Growing evidence of economic revival in the US, though, injected some realism into the bond market over the summer.

A further rise in bond yields seems likely over the balance of 2003 and in 2004 in response to a continued strengthening of economic activity. However, continuing low official interest rates, relatively steep yield curves and subdued inflation should help to limit the rise in yields from here. We see 10 year eurozone and US yields increasing to 5 per cent and 5.3 per cent, respectively, by end 2004

Donal O’Mahony
Seeing will be believing for a currently soured and agnostic investor base, the result being an unwinding of the embedded 2004 tightening fears that permeate both US and European money-market strips. In consequence, a combination of osmosis and gravity will pull longer-term bond yields lower, thereby flattening global yield curves from their current historically elevated readings.

This prognosis warrants continued preference for floating rather than fixed-rate borrowings, given the medium-term stability of the central banks’ policy footings and the current exaggerated premium in longer-dated bond yields.

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