Market opinion: the results

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Mitchell Fraser-Jones 12 June 2015 Est. reading: 6 min read

On Tuesday, we asked our readers to answer five questions that had previously been posed to professional bond investors at a Deutsche Bank conference earlier in June. We were delighted to receive more than 900 responses to the survey and are pleased to share the results below, along with those of Deutsche Bank’s original responses and, for interest, Neil’s own answers.

Question 1: Where will Bund yields be at the end of 2015?

Chart showing results of question 1

So half of the Deutsche Bank audience thought that German Bund yields would end the year between 1.0% and 1.5%, with many more seeing them lower than this level than higher. Interestingly, the Woodford readers vote was much more evenly cast – 1.0-1.5% still gained the highest share but the distribution of higher and lower votes was much more even.

Perhaps this simply reflects what has happened to European bond yields since the Deutsche Bank event last week? But it is also interesting to note that there were more Woodford reader votes for below zero yields in Germany by the end of the year, which appears to contradict that theory.

Neil Woodford expects 10yr Bund yields to end the year between 0.5% and 1.0% and commented:

This is a difficult call because I see a number of conflicting influences playing out in the German bond market over the rest of 2015. Some – primarily QE – will be negative for prices. As we have pointed out before, during periods of QE, bond yields tend to rise – this was certainly the case in the US and UK. The consensus view (which I do not agree with by the way) is that QE works and, consequently it is ultimately bad for bonds because it will raise growth and inflation.

Other influences, however, could be positive for bonds. For example, their safe haven status in an uncertain world is undiminished and could easily come to the fore again in the event of a Greek default, for example. Also, slowing global growth and the continued threat of deflation will continue to lead to demand for Bunds.

In part, this is a particularly difficult call because it is such a short-term question. My answer reflects my view that the recent bond tantrum has probably now played out and that the ‘bond positive’ influences may reassert themselves over the remainder of the year.”

Question 2: When will European Quantitative Easing end?

Chart showing the results of question 2

A pretty similar set of results between the two polls here but Woodford readers on average appear to see European QE lasting longer than the professional bond investors attending the Deutsche Bank conference. In particular, the greater than 10% of Woodford readers expecting ECB QE to continue beyond 2020 stands out.

Neil expects European QE to last until 2018, explaining:

European QE will continue because it will not deliver the real economic outcome that its architects have hoped for. They will live in hope, however, and argue that if QE was larger and had more time, it would work. I don’t think this is true but given the lack of alternative policies and the constraints around fiscal policy, I don’t believe that they have any other option but to pursue more QE. Consequently, I see it continuing well beyond the current Q3 2016 anticipated end date, with a second similarly-sized programme of asset buying following behind it.”

Question 3: Will the Federal Reserve raise rates this year?

Chart showing the results of question 3
These results were starkly different. Nearly 60% of Deutsche Bank’s audience expect US interest rates to rise later this year. For Woodford readers, it’s broadly 50/50 – with marginally more people expecting no rate rise this year in the US. Again, perhaps we have to consider whether events in the last 10 days have done anything to change likely voting behaviour for both groups, but this looks unlikely – if anything the US data has suggested a greater likelihood of a US interest rate rise in 2015.

Neil is firmly in the “no” camp here:

I continue to believe that Janet Yellen and some other Fed committee members remain very concerned about the implications of raising rates – especially whilst inflation remains so low and growth weak. The hawks on the committee are focused on the labour market and the unemployment rate which they see as the lead indicators of rising wages and higher inflation later. I think when push comes to shove the doves will win the day and therefore rates will not rise in the US this year. I also happen to think that the doves are right to be more concerned about the underlying weakness of the US economy and the hawks wrong about wage inflation.”

Question 4: Where will the Fed Funds Rate peak this cycle?

Chart showing the results of question 4
There’s a very similar distribution of votes here between Deutsche Bank’s audience and Woodford readers. Both samples are tending to expect a lower peak in interest rates than normal which, given all the well-known headwinds, is perhaps not surprising.

Neil’s view on this subject was that, when interest rates do start to rise in the US, they won’t rise far at all:

This answer follows naturally from the previous question. The underlying fundamentals of the US economy, although stronger than those of other developed economies, remain fragile. If interest rates do start to rise in 2016 (not at all clear cut, in my view), I do not see them increasing far from the zero bound. In summary, the weak growth and deflationary forces playing out globally will continue limit the scope for higher policy rates everywhere.”

Question 5: When will the next above average default rate year occur?

Chart showing the results of question 5
For context here, 12 of the past 13 years have seen below average default rates – this can’t continue forever. But when will the trend break? Jim Reid, Head of Global Fundamental Credit Strategy at Deutsche Bank, suggested that the results of his survey suggested that investors, while sanguine in the near term, “don’t necessarily think we’re in a permanently low default world, which it sometimes feels like”. It seems Woodford readers are slightly less sanguine in this regard, tending to see an earlier return to above average default rates than Deutsche Bank’s professional bond investors.

Neil sees the trend of below average default rates potentially breaking in 2018, and explained:

Again, a difficult question to answer but one that focuses the mind. I would expect default rates to remain low for the foreseeable future, as they have done for some years now, suppressed by extraordinary monetary policy (zero rates and QE) and the underlying weakness of bank balance sheets (inadequate capital means loan losses cannot be taken, hence pretend and extend). Given my views on growth, inflation and interest rates over the next 3-5 years it may well be that default rates remain very low beyond 2018.”

So to wrap up, some thought-provoking insights into where the market consensus currently seems to be and some interesting contrasts between the two polls! Overall, we would suggest that the Woodford readers poll has a slightly more cautious tone to it than the Deutsche Bank one. The time differential (early-June vs mid-June) might have had a slight influence here but, alternatively, perhaps our readers have been conditioned slightly by the realistically circumspect tone of our economic musings over the last twelve months? Or, maybe our readers display a natural bias towards a view of the world similar to our own?

Whatever the explanation, thank you for taking part. Clearly, it’s worth pointing out, as some of Neil’s comments imply, this is quite a short-term survey when you consider our long-term investment strategy. But it’s been a bit of fun and we hope you’ve found the results interesting.

Ultimately, one thing is for sure – nobody knows the answers to these questions. All we can do is think about them and invest with them in mind in a long-term context. Only time will tell which are the correct answers…

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address: 27 Old Gloucester Street, London, WC1N 3AX.

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