Unstructured Finance

Gerard Fitzpatrick: Positive on global growth

March 29, 2011

Guest blogger Gerard Fitzpatrick is portfolio manager at Russell Investments, where he runs a $5 billion global bond fund.

The views expressed here are entirely the author’s own and do not constitute Reuters point of view.

The global economic outlook is positive overall, currently powered by China and America’s twin engines of growth. Questions have been asked about the level to which the Japanese disaster may slow down the world’s economic recovery, but in reality, it’s expected to have only a small negative effect on global growth this year.

Europe remains constrained by the Euro sovereign crisis, and we expect to see only low levels of European growth. Europe is moving in the right direction, but there are still lingering challenges. Despite Greece and Ireland remaining at risk of default, the economic outlook is moderately positive.

The Portuguese parliament has taken a striking gamble that will be acutely monitored by other European governments and bond investors. If they continue their refusal to accept harsher austerity measures, the outcome for Portugal could simply be binary, where either deeper support from the bailout providers will be made to balance the books or their refusal to accept such harsher austerity could push the already politically stretched bailout providers to breaking point. At an extreme, this could push Portugal into an abyss of confidence with bond investors and rating agencies.

Previously, the best stand-alone defence peripheral European governments held versus an ever increasingly sceptical bond market was a commitment to austerity measures to help stem the rising tide of indebtedness. If you take that defence away, the gambling peripheral country could drown.

The world has only just come out of a recessionary environment, and we expect inflation to remain relatively low in key global bond markets for several reasons.

Firstly, companies still have substantial spare capacity, with any increase in demand being gladly met and not leading to higher prices sought.

Secondly, there is continued low wage growth, with sellers having limited opportunities to seek higher prices from their “cash constrained” customers.

Thirdly and finally, banks are still reluctant to lend, putting limited pressure on the circulation of money.

The key risk positions in our global bond fund are diversified across interest rates, currencies and credit. These factors are all expected to provide additional returns for global bond holders, in addition to government bond returns, leading to an expected positive absolute return this year, albeit likely to be lower than the previous two years’ above-average returns.

Given the current low interest rate environment, following the global financial crisis, coupled with signs of global economic growth, we expect to see a modest increase in global government yields over the rest of this year. However, we don’t expect to see a significant rise in yields, due to the low inflation outlook.

The Euro and the Yen are the key currency watch points, given the continued sovereign debt concerns in Europe and following the tragic earthquake event in Japan. We currently have underweights towards the Euro and the Yen. We expect
volatility in the short term with these currencies, but believe that they are ultimately overvalued.

Our current sector position is an overweight to credit bonds, due to the improving economic fundamentals feeding into a lower expected default rate.  We expect to see continued strong demand for higher yielding credit assets given the low yielding government bond alternative and given investors’ increased confidence to seek higher yielding income, supported by the more positive economic outlook.

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