Mark Glowrey's Weekly Bond Market Overview
Comment of the Day

October 07 2013

Commentary by David Fuller

Mark Glowrey's Weekly Bond Market Overview

My thanks to the author for his informative report, published by Canaccord Genuity. It is posted in the Subscriber's Area but here is the opening
Last week saw the gilt market tread water within a fairly tight sideways range, holding just above the August highs but drifting back from prices levels reached earlier in the week. The yield on the 10yr benchmark stands at 2.7%, having recovered fairly swiftly from the somewhat oversold condition seen in the late summer, where yields stood at 3%. Recovery in bond prices has been seen across the curve as investors become more sanguine bout short-term interest rate rises and rotate "risk off".

But, the big unknown is the US government shutdown, which raises the unthinkable prospect of a default. Of course, we have been here before and the usual form is a sell-off in risk assets, and outflows from the USD dollar combined with a pick-up in general volatility. In the past this pattern has been followed by a relief rally as the budget is passed and the debt ceiling raised. The such last impasse was in 2011 - where we saw equity markets drop sharply (the S&P dropped over 5% in one day). Following these events, S&P downgraded the USA's credit rating, US Treasury prices remained firm, ironically boosted by a "flight to quality".

David Fuller's view When the distinctly partial shutdown of the US government occurred last week, pundits who were talking their stock market book were saying that it would last for 2 to 3 days. Now that this political impasse is in its second week people are a little more wary and this is reflected by market prices.

Short covering presumably accounted for most of the initial rise in bond prices (fall in bond yields) and we could see some temporary 'safe haven' buying, as Mark Glowrey points out, until politicians fully agree to reopen the US government. In stock markets, the uncertainty is deterring further demand for equities, despite the powerful, ongoing tailwind of exceptionally accommodative monetary policies by many central banks, including the US Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan.

Meanwhile, we can be certain that Republican and Democrat politicians are nervously monitoring public opinion polls. Given the poisonous environment between these two parties, I assume that unless a bout of commonsense takes hold, or more likely an even worse poll rating than they had hoped for is reported, this standoff could go down to the debt ceiling wire on 17th October.

In that event, I assume government bond yields including (10-yr UK Gilts and US Treasury Bonds) shown on daily charts will be a little lower. Their respective stock markets (UK and USA) could easily fall more quickly as shares are generally more volatile than bonds. However, many high-beta stock markets would be more susceptible to temporary selling pressure, especially in countries where monetary policies are less accommodative.

The good news is that further sell-offs caused by the US political impasse would create short-term buying opportunities for quality shares, not least Autonomies which are either temporarily oversold and/or have eased back and are encountering support near their rising 200-day moving averages.

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