| After a volatile third quarter, uncertainty ahead |
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| Finance invited bond and currency market experts to give their outlook for the coming quarter and predict the level of key indicators at quarter end. The following are the assessments for the current quarter and look back at how Q3 predictions compared with the outcome. |
Bond ranges narrowed in Q3
Colin Hunt,
Chief Economist, Goodbody Stockbrokers
US Fed funds - 6.50%
10 Year bond - 6.05%
ECB repo - 5.00%
10Y bund - 5.20%
BOE Base - 6.00%
10Y Gilt - 5.10%
IRL/GER 10 year spread: 19 bps
Looking back: The US data have been so kind that Greenspan didn’t need to put the pre-election insurance hike that we expected in place. With the slow-down story becoming more convincing by the day, we are increasingly confident that the next move in US interest rates will be in a downward direction. Our anticipation of a turning point in the Anglo-Saxon interest rate cycle seems well on the way to being realised. The ECB and the BOE behaved as expected over the quarter with common sense firmly entrenched in Threadneedle St while more than a whiff of panic hangs over the Eurotower. Bond markets overall performed marginally better than expected over the quarter with the pace of the moderation in US economic activity surprising even a few old bulls.
Looking forward: Expect to see more of the same from the monetary authorities. Stability in US and UK rates seems to be on the cards out to the end of the year although we believe that the policy bias in both jurisdictions will be on the loose side of neutral by Christmas. The ECB will continue to tilt at windmills, spotting growth momentum where none exists, pushing interest rates upward again and expecting the world to respond to this horrendous monetary muddle by bidding the euro higher. While we retain our view that the best of global growth is well behind us, we believe that the US market has a lot of good news priced in. A few pre-election jitters on the fiscal rectitude front would be enough to push longer-dated yields a little north from here. In the UK, an enhanced credibility premium for the BOE should be supportive as should signs of slowing growth. Meanwhile in Europe, more sluggish domestic demand signals are bound to emerge from Euroland as the full impact of ECB tightening is felt. With economic activity set to disappoint and with a recovery for the euro a possibility for 2001, bunds could be the big play next year.
Oliver Mangan, Chief Bond Economist, Primary Dealer Unit, AIB Group Treasury.
US Fed funds +25bps 6.50%
10 Year bond +15bps 5.90%
ECB repo - +50bps 4.75%
10Y bund - +20bps 6.30%
BOE Base - +25bps 6.00%
10Y Gilt - 20bps 6.40%
IRL/GER 10 year spread: 20bps
Looking Back: A slowdown in the pace of economic growth saw monetary policy left unchanged in the US while the ECB responded to rising inflation in Euroland by hiking rates by 25bps. The Monetary Policy Committee in the UK voted 5:4 against hiking UK rates in both August and September. US bond yields moved somewhat lower in July as economic growth decelerated, while in Europe, bond markets continued to move in a narrow range during Q3. On the home front, Irish yield spreads tightened in to Germany reflecting the strong fiscal situation and associated favourable bond supply outlook
Looking Forward: A deceleration in the pace of economic activity suggests that monetary policy will remain unchanged in the US over the balance of the year. The ECB, though, tends to focus solely on inflationary pressures and thus is likely to hike by another 25bps in Q4 given that the CPI rate remains above target. A lethargic UK economy suggests that the doves may continue to hold the upper hand at MPC meetings and rates will stay at 6%.
A lot of counteracting influences remain at play in bond markets - high oil prices, signs of decelerating economic growth, nervous equity markets, more stimulatory fiscal policies but - decreasing issuance. With not much action expected from central banks, it may well be that bond markets will continue to range trade over the final quarter of the year. Our forecasts reflect this expectation.
Dermot O’Brien, Head of Economic Research, NCB
US Fed funds - 6.50%
10 Year bond - 5.75%
ECB repo - 4.75%
10Y bund - 5.35%
BOE Base - 6.00%
10Y Gilt - 5.15%
IRL/GER 10 year spread: 15bps
Looking back: The ECB behaved as forecast but the Fed and Bank of England proved more relaxed than we thought, eschewing the rates hikes we believed they would implement for insurance purposes. US treasuries performed broadly as expected but European markets were somewhat disappointing. Ireland, however, finally made some headway in narrowing differentials with Germany.
Looking forward: We expect to see at least one further quarter-point rate hike from the ECB over the remainder of the year but in the US we expect policy to be held unchanged. Since they have remained inactive for so long, we doubt the MPC in the UK will resolve its internal debate so we expect unchanged policy there too. European bonds look overly complacent about monetary policy and we think there will be some slippage over Q4 as rates rise and the impact of short-term buy-backs wanes. We think the vulnerability of the Irish market in this scenario will be reduced by the prospective scarcity of issuance in the near future and dramatic longer-term buy-back prospect. As a result, we should see differentials narrow further by year-end. Though policy may be on hold in the US and UK, the prospects of rate cuts remain distant so progress in their respective bond markets looks likely to be small in the period ahead. |
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| Article appeared in the October 2000 issue.
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