Tentative signs of economic growth, receding risks, plentiful nearly free liquidity and financial markets on fire ? what was not to like about the investment landscape at the end of 2013? It is tempting to believe that what happened 'yesterday' will happen again 'tomorrow' (especially if momentum has been paying off, as it did in 2013). So what is the potential outlook for investors this year?
Global bond markets for the remainder of 2014 are expected to pay close attention to the actions of the US Federal Reserve (Fed), which has started to wean the US (and global) economy off its $85bn per month quantitative easing programme.
The news that the Fed would initially taper its programme by $10bn per month according to Jupiter Investment Management Group (30 January 2014) was at the dovish end of expectations and was greeted well by bond and equity markets. The lower-for-longer tone to the Fed's forward rate projections was also positive. It underscored that the Fed believes the economic recovery still has some way to go and affirmed the central bank's desire not to relinquish control of the yield curve and cause undue weakness in the economy and markets.
Credit markets
The outlook for credit markets in 2014 is also optimistic, with economic data broadly meeting expectations and the market factors in an orderly process. Under this scenario, there is potential for high yield bonds to produce decent returns. However, the Fed faces a formidable task. There is a risk that economic data will come in a lot stronger than expected. This may lead to a market panic over the pace of rate rises and potentially bring forward expectations for a rate increase to later in the year, igniting a 1994-style market reversal.
This seems unlikely for now, as low US inflation is currently giving the central bank cause for concern and a justification for maintaining a gradual approach to tapering. In his speech, the former chairman of the Board of Governors of the Federal Reserve, Ben Bernanke, highlighted that the Fed may consider further action if inflation did not move up towards its 2% target. However, should growth start to accelerate, US inflation data will receive close scrutiny and is likely to be a particularly important indicator for shaping bond market sentiment in the coming year.
UK economic growth
Closer to home, the Bank of England recently responded to a pickup in UK economic growth by bringing forward expectations for when unemployment would fall to its 7% target to December 2014, some 18 months earlier than previously indicated. While this was largely expected by the market, a further acceleration of growth in the UK economy at a time when the Fed is withdrawing stimulus may cause headaches for the Governor of the Bank of England, Mark Carney, and push gilt yields higher.
In Europe there is mounting evidence that the economy is bottoming out and we are now in a situation where growth is not great anywhere, but growth is everywhere. Although mindful of the difficulties the European Central Bank (ECB) faces in addressing the economic divide between Germany and the region's weaker economies, there is encouragement by efforts (such as the bank asset quality review) to boost confidence and ultimately promote credit growth in the peripheral economies. However, the ECB may be forced towards more unorthodox policies should the shift in the Fed's stance force interest rates higher in the region.
European high yield bonds
In terms of strategy, the view is that European high yield bonds present some of the most compelling opportunities available for investors in fixed income. The region is enjoying low default rates, companies continue to focus on repairing balance sheets, the economic backdrop is stabilising and interest rates are likely to remain low for a prolonged period. These conditions contrast with those in the US where companies are more confident and therefore more willing to take on leverage.
The value of investments and income from them may go down. You may not get back the original amount invested. Changes in the rates of exchange between currencies may cause your investment and any income from it to fluctuate in value.Commentary may be subject to change and this is particularly likely during periods of rapidly changing market circumstances and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given.
