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Beware EM credit bubble: Capital Economics' key 2014 calls

by Dylan Lobo on Jan 09, 2014 at 14:18

‘The end of bond purchases under prior episodes of QE did not always entail a surge in their yields, as it dulled investors’ appetite for risk. We may see something similar with the phasing out of purchases under QE3,' he said.  

‘What’s more, the FOMC’s strengthened forward-guidance suggests that expectations for short-term interest rates in coming years are likely to remain low. Indeed, if the committee is successful in anchoring short-term rates, there is little reason to expect long-term yields to rise sharply.’

Although Higgins believes the Fed will ‘tread very carefully’ and only begin to raise rates in 2015, he expects the anticipation of a tighter rate stance at a later date to cause 10-year treasuries to drift up to a 3.25% yield.

He does not expect gilts to be immune to events across the Atlantic but still sees some scope for UK government bonds to outperform treasuries and end the year at 3%. Higgins puts this down to the ‘wrongly’ expected view that UK interest rates will rise in 2015.

‘We no longer expect much of a lag between eventual first rate hikes by the Fed and the Bank of England,’ Higgins said.  

‘However, the pace of subsequent monetary tightening may be slower in the UK than in the US, not least because the stance of fiscal policy in the former is likely to be considerably more restrictive.’  

Meanwhile Higgins anticipates bunds drifting higher over the year, although with no rate rise on the horizon in Europe he expects yields to creep up to 2.25% by the end of 2014.

Elsewhere with yields on long-dated JGB’ decoupling from treasuries in reflection of the differing outlooks for Japan and the US, Higgins forecasts the yield on the 10-year JGB to close the year at 0.75%.

Finally Higgins believes prices of dollar-denominated emerging market government bonds are likely to come under some pressure ‘from further increases in both underlying US treasury yields and credit spreads,’ the latter of which reflects diminished appetite for risk.

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