Bond Markets – Key Risk for Equity Markets!

• Look at the way the yield on gilts has been moving, or for that matter the yield on 10-year US Treasuries. You would have thought that, with action like that, no one would want to bet on the Fed lowering rates, yet according to the latest Reuters poll of primary dealers in the US, 15 out of 21 still expect rates to be cut. Of the 15, many expect a rate cut before September. Well, maybe! But the US Treasury market isn’t buying it and I know the horse I’d rather back - for now.

• Central banks are worried that the risks for inflation are on the upside. In the UK, the MPC has noted repeatedly that companies are in a stronger position than before to raise prices and in the US the Fed has been consistent in saying that its main concern is that inflation ‘ … will fail to moderate as expected’.

• Given this and the fact that forecasts for economic growth outside the US are being revised up for this year and next, it’s hard to imagine that the central banks are getting ready to relax monetary policy.

• The US economy doesn’t look all that weak. Inventories have been run down, which is why new orders in manufacturing are picking up. Also, the underlying tone remains firm within the service sector. The dollar is still tending towards weakness, which is further good news for domestic producers of US goods and services. That’s good news also for employment, which is growing more strongly than expected anyway, and that in turn, is good news for consumer spending.

• Although the bond markets are looking oversold, and may rally a bit, a better buying opportunity may still lie ahead. The Treasury market senses that the US economy is likely to regain momentum and that the next move in the Funds rate will be up, not down. That view is not reflected in consensus thinking and therein lies the risk to equity markets, not to mention all those leveraged plays.

• Strategically, we’re positive on equity markets. But if and when consensus thinking shifts on interest rates, equity markets could be in for a sell-off. Tactically, it may be right to be cautious!

* The information contained in this report has been taken from public sources and is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. The opinions expressed in this document are not the views held throughout Brewin Dolphin Securities Ltd. No Director, representative or employee of Brewin Dolphin Securities Ltd. accepts liability for any direct or consequential loss arising from the use of this document or its contents. We or a connected person may have positions in or options on the securities mentioned herein or may buy, sell or offer to make a purchases or sale of such securities from time to time. In addition we reserve the right to act as a principal or as agent with regard to the sale or purchase of any security mentioned in this document. Prices, values or income may fall against the investor’s interests. You should therefore be aware that you may get less back than you invested. Past performance is not a guide to future performance. If you are in any doubt concerning the suitability of these investments for your portfolio, you should seek the advice of a qualified investment adviser.