Fixed Income  

US bonds ‘approaching fair value’

US government bonds are approaching fair value following the summer sell-off even as the Federal Reserve gears up to announce the ‘tapering’ of quantitative easing (QE), according to bond managers.

The yield on the 10-year US treasury bond has risen from 1.63 per cent on May 1 to 2.86 per cent on September 4, as bond prices have fallen following Fed chairman Ben Bernanke’s announcement that it would begin reducing the amount of money it is pumping into the US economy every month.

The Federal Open Market Committee, which sets US monetary policy, is due to meet on September 17 for its monthly meeting and is expected to set out how ‘tapering’ of QE will take place.

But bond managers said the sell-off in bond markets had gone “too far” and presented

a buying opportunity, even though markets were set for more volatility when tapering is finally announced.

“Markets at the moment see QE ending next year and interest rates increasing after, but we struggle to see it imminently,” said Mike Amey, Pimco’s head of sterling portfolios.

“The best opportunities are in short and medium-dated bonds in the US where you are betting against a first rate hike at the end of next year. Markets have got ahead of themselves in terms of the speed of the sell-off.”

M&G Investments’ Stefan Isaacs, deputy manager of the firm’s £16bn Optimal Income fund, said: “As we’ve seen bond yields go significantly higher they are starting to look closer to fair value.”

He added that M&G’s bond team was starting to increase its funds’ duration – a measure of sensitivity to interest rate expectations – having kept it low through most of 2013.

“Tapering shouldn’t come as a shock and a reason to sell off – the market has priced in a lot of downside,” Mr Isaacs said.

Nick Gartside, chief investment officer for fixed income at JPMorgan Asset Management, said with US and UK government bonds approaching “fair value” the asset class had “become a question of fundamentals”, such as underlying economic strength.

He added: “The devil of tapering will be in the detail: the amount it is reduced by and how it is reduced.

“There’s been very little direction since July but as we get more certainty [from the Fed] and markets price this in there will be more directionality – the question is: which way?”

Smith & Williamson’s head of fixed interest Chris Lynas said it was “too early to call the death knell of the secular bull market” and said US treasury bond yields could move back down to 1 per cent from their current levels.

But David Zahn, co-manager of Franklin Templeton’s Strategic Bond fund, said he expected government bond yields to be higher in 12-18 months’ time as economic growth improves.

He added: “Look at where the real yields are in the US and UK: 10-year bonds are yielding zero. You can’t say it’s a buy unless you think growth is going to slow.”