Cautiously Optimistic

February 2005 | Bond Sentiment Index

Ahead of the recent decline in US Treasury bonds, which pulled EM debt prices back from a brief period at all-time highs, our surveyed investment banks were still optimistic towards the asset class in general. In fact, our global Bond Sentiment Index is unchanged in February at 100.40, reflecting the bullish view of the investment community even with spreads at record lows. Recently, we have highlighted the eurodollar futures market as a potential harbinger of risk to EM debt. The weak technical outlook suggests that the Federal Reserve may raise interest rates more than previously anticipated, which could potentially weigh on US Treasury prices. However, despite Chairman Greenspan's warning that real rates are still low, inflationary pressures in the US remain relatively benign. Core CPI is running at around 2.3% y-o-y, which suggests a continuation of the measured approach to monetary tightening. As a result, the futures market may well be discounting too much of an increase over the coming 12-18 months. In any case, the rate hikes so far have given rise to a flattening of the curve, with the yield on the 10-year staying low, due in no small measure to structural changes in pension fund portfolio management and heavy purchases by Asian central banks. Both phenomena, we feel, are unlikely to change soon, which should therefore sustain the global search for yield. The short-term eurodollar risk cannot be ignored, though, and with this in mind, we reiterate our view that the strengthening fundamentals of EM debt will cushion any US-Treasury induced declines, whilst acting as a catalyst for further price gains when Treasuries are stable.

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