Geoff Cutmore - Morning Thoughts

Beware Snapback

Geoff Cutmore
A view into the trade hall of the Commerzbank in Frankfurt, central Germany
Michael Probst

Investors have to ask themselves some critical questions this week. Chief among them: are higher Treasury yields here to stay and are we close to the top in yields?

David Tavadian of Commerzbank said he felt we are likely to see 6% or more on the ten year. That means the markets in all asset classes must get used to a steeper sloping yield curve.

So how do you handle a portfolio of bonds?

David thinks you would have to be fairly brave to be an aggressive seller and he thinks there is still good money to be made in well-capitalized emerging markets, for example Russia, which is well supported by energy revenues.

The move over the last two weeks was very quick. With such a violent move there is a reasonable likelihood of a counter-trend rally. But watch out for any selloff in corporate credits and emerging debt. Stephen Roach at Morgan Stanley is looking for 'Act Three' for confirmation that it is all over.

Has the market grown too complacent about risk?

Perhaps the market had become too optimistic about the prospects of Fed rate cuts. The move in yields can be seen in terms of the market re-pricing the short end of the curve.

Is it a more generalized re-pricing of risk? Perhaps not. Apparently Asian and emerging equity markets continue to enjoy gains. Peter Toogood of Forsyth Partners expects equity markets to continue to benefit from liquidity. The price of money maybe steadily rising, but in fact corporates should continue to benefit from a combination of benign rates and modest inflation.

A final thought, Mr Sarkozy has his mandate. France looks set to enjoy a re-rating so long as he can hold his nerve on the reform agenda. It is going to be a long summer for the French. Watch the industrial disputes closely. If the government can hold its nerve, rather than cave in, a la Chirac, the CAC should be a comfortable place to play.

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