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Investors Should Avoid Sovereign Bonds: Report

Japan, the US and the UK will retain zero interest rates policies until at least early 2014, according to a December report by Swedish bank SEB.

Interest rates
Interest rates

“Lower inflation will enable central banks in many OECD countries to continue their zero interest rate policies for an extended period. Major industrialized countries will probably also launch more monetary quantitative easing ,” said the report, written by a team of strategists and economists.

At present, base rates are at 0.1 percent in Japan, 0.25 percent in the US, and 0.5 percent in the UK.

Downward pressure on prices due to low base rates, coupled with the likelihood of higher yields materializing “sooner or later”, mean investors should steer clear of‘safe haven’government bonds from OECD countries, added the report.

“There is now significantly less room for higher government bond prices… Given today’s low yields, returns from bonds will not be as good [as previously]… Rising yields, which will materialize sooner or later, will provide a negative return,” the report said.

Instead, investorsshould consider high yield corporate bonds, said the report, which based on fundamentals – in terms of company health and bankruptcy risk – have “unjustifiably” wide yield gaps to government securities.

The high yield sector displays, “A good earnings trend, substantially lower indebtedness, a considerably higher percentage of liquid assets in balance sheets, and extended maturities on company bond loan maturities,” said the report.

In addition, the authors said pricing in the global high yield market overcompensated investors for bankruptcy risk, pricing in a 7-10 percent risk of bankruptcy. However since the beginning of 2011, only 17 out of 1,291 issuers in the global high yield index have gone bankrupt, equivalent to a rate of only 1.3 percent.

The authors added that emerging market government bonds still remain attractive, due to high coupons, and in some countries, potential for falling yields (i.e. price gains). The strong appreciation in the dollar could also provide scope for exchange rate gains.

“In the emerging market countries, public sector deficits are far smaller, money market rates are actually falling, inflation is slowing and government bonds are tempting to investors if risk appetite increases,” they said.

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