Divyang Shah, Senior IFR Strategist
When there is a shortage of safe haven paper and the major central banks are still engaged in QE it is difficult to get excessively bearish on the major bond markets. It is for this reason we see the current bond market sell off as a correction as opposed to a time to get bearish bonds.
Yes, yields could have more in the way of upside but we must remember that we are coming off yield levels that are still considered low.
What has been amazing is how the correction was delayed for so long given the series of fresh highs for equities, peripheral rally and grab for yield in the high yield and non-traditional EM bond markets. The correction on the major bond markets should be viewed as supporting the potential for risk taking on these other asset markets to continue.
Yes some money will flow from bonds and into equities but this is not a great rotation as there is still a large section of the investment community that does not want to participate in the liquidity fueled risk rally. Concerns also remain that the current risk rally does not have any fundamental backing given that it comes at a time when global growth and inflation risks are pointing to the downside.
Over the coming months expect:
1) a continuation of the risk taking trade especially on equities and
2) major bond markets to eventually stabilise after what could be a violent correction.
The pendulum of market psychology has swung from extreme pessimism to neutral and is now swinging the other way as investors and portfolio managers are forced to partake in the risk rally for fear of missing out. When the music is playing it’s difficult not to get up and dance.
