The threat of potential deflation is likely to persist next year, which could mean another great year for bondholders, Canada Life Investments David Marchant says.
This year global growth has diverged with the UK and US posting strong numbers compared with the funk of Europe and Japan.
The sustained demand for bonds has boosted prices and caught many wrong-footed – and the last gap rally could last a bit longer still, he says.
Looking to the year ahead Marchant, who manages the CF Canlife Portfolio funds range, outlines the world as he sees it.
Threat of deflation will linger
Most developed countries are experiencing disinflation, while the eurozone is flirting with all out deflation, Marchant says.
The currency bloc has a combined inflation rate of 0.3 per cent and the small improvement seen in some peripherals has been eclipsed by “anaemic growth” and deflationary pressure.
“Should Europe fall into deflation, it would have a dramatic impact on growth and investment returns,” he says.
“It would also have a negative effect on the UK economy as European demand for British exports would fall. Despite this, we expect the eurozone to return to growth and see rising inflation in the coming year, albeit at a slow pace.”
Central banks will remain supportive
The “uneven” economic recovery has meant a divergence in central bank policies worldwide, Marchant says.
“Just as the US Federal Reserve ended its quantitative easing programme, the Bank of Japan shifted its monetary easing programme into overdrive.
European Central Bank president Mario Draghi continues to hint at further easing measures as well, however Marchant is unconvinced the ECB will launch “fully-fledged QE”. He believes it will continue to rely on words rather than actions.
“So what will happen to QE globally in 2015? We expect to see continued recovery in the US balanced by sluggish growth globally,” he adds.
Interest rates might not rise at all
The consensus for the first interest rate hike, either in the US or UK, will happen late next year, Marchant says.
“If there is anything to learn from 2014, it is that we should not rely on an interest rate rise taking place any time soon,” he argues.
“[This year] opened with commentators speculating how soon interest rates would start to rise. That all changed when both the US Fed and the Bank of England determined that their respective economies were not yet back to full health.”
The recent disinflation has worried many and put the strength of global growth – feeble as it is – in doubt.
“We might see the first rate rise delayed further,” Marchant says.
“Will this mean no rate rise until 2016? Don’t rule it out.”
Bond markets to climb higher
That late-2013 consensus for increasing bond yields was forged during a period of stronger growth expectations and with the view that fixed income demand would fall as the Federal Reserve turned off the QE tap.
“However, despite the US and UK delivering solid economic growth in 2014, low inflation, worries about European growth, a slowdown in China and a raft of geopolitical tensions weighed on sentiment and supported lower-risk assets,” he explains.
“For the same reasons that we believe the first interest rate rise might not occur in 2015, we do not rule out the likelihood that bond markets could continue to see high demand in 2015 if economic uncertainty persists.
“Government bond yields might already be low, but this does not mean that they cannot fall further.”
Asia to outperform
After a bit of wobbling, Asia “is back”, Marchant argues.
“Valuations appear cheap, fundamentals are strong and a wave of reforms across the region has lifted spirits.
“Although cautious in our approach to the US and somewhat concerned about the health of Europe’s economy, our view of Asia Pacific is positive.”
The region is benefiting from large structural changes and steady demand from its growing middle classes, he adds.
“Even though we believe that the UK remains good value in the current climate, it is unlikely to match Asia Pacific’s growth in the coming year.”