There will be no interest rate rise announcement from the Bank of England until after the referendum, according to JP Morgan.
Even after the vote, the UK will need to see better economic growth before rates increase according to Iain Stealey, co-manager of the JP Morgan Global Bond Opportunities fund, speaking at a press briefing in London this week.
In the event that Britain votes to leave the European Union, Stealey said the UK economy would not immediately shut down, and it would take time to figure out the real consequences to the economy.
“There are 66 trade negotiations that would need to be done in over 24 months. That’s going to take time to come through,” Stealey said.
In the event of a leave vote, his co-manager at JP Morgan, Nick Gartside, predicted that the Bank of England would reduce interest rates further, in addition to more quantitative easing in the short term. UK government bonds, also called gilts would post positive returns under this occasion, but the value of sterling would fall. In the medium to long term, Gartside said that the outlook was unclear and said it all depended on the “divorce settlement” between the UK and EU.
Expect a More Volatile Environment
It is currently a challenging environment for all investors, across asset classes. Volatility continues to go up – and investors have to get used to it, said Gartside. But they should learn that volatility also provides opportunities.
“One of the lessons in recent years is you have to avoid concentration risk. That means avoiding single sector and single country bond funds,” Gartside concludes. “It’s about understanding the risk. Try and find a way to reduce or manage those risks by thinking broadly and globally.”
Gilts: Best Asset Class of 2016, But Where Next?
Facing the headwinds of political uncertainty, UK government bonds have done well, and was the best asset class of the year, two managers said. However there are five more areas elsewhere in the bond market that two managers considered “a big opportunity set”. Three of them are in Europe and two are in the US. They can all generate decent returns over the next 12 months – an inflation busting 5%, according to two managers.
US High Yield Ex-energy
The JP Morgan bond managers think that taking a bet on the whole US high yield market is too aggressive a stance, regardless of the attractive 8.5% yield. Instead, they choose to strip out the energy companies, leaving an average 6% yield. This also reduces the risk of default as ex-energy default rates are low. In an environment where government bond yields and cash interest rates remain very low, US high yield ex-energy looks an attractive bet.
Peripheral Government Bonds
There was a lot of scope for government bond yields or spreads to tighten further in certain parts of Europe, Stealey said. Adding he saw a lot of potential for growth in peripheral government bonds. These include issuance from Spain and Germany.
European High Yield
If investors are comfortable that Europe will continue to recover and the European Central Bank is supportive of the market, the fundamental picture is bonds look decent and there’s attractive yields there, Stealey says. He expects a yield of 3.15% to 5% from the European High Yield sector, which he says looks attractive in the world of no yield or negative yields. There is little to no supply coming to the market either, but there’s lots of demand from investors, he adds.
European Banks
Negative interest rates may be bad for banks in terms of earnings, but it is very different from the bondholders’ perspective, the JP Morgan fund managers say. European banks are downsizing; getting out of North America and Asia, making them more focussed on their core business which is strong. There is more confidence following last week’s policy that the ECB is supportive of the banking sector, and that the central bank will continue to find “inventive ways” to support banks while trying to promote growth in the broader economy.
Long-dated Corporate Bonds
Long-dated corporate bonds currently yield anywhere from 4.5% to 6% with a long duration risk, say the fixed income investors.
