Euro inflation a worry for bonds

13th October 2010

Adam Cordery, head of European and UK credit strategies at Schroders, says that while he does not believe Europe will slip into recession next year, he does expect the credit quality of companies to continue improving, resulting in default rates coming down. That in turn should help support tighten credit spreads.

Investors recently have been exercised by concerns such as a double-dip recession and even the collapse of some European banks. Such fears have forced them to seek safe havens such as government bonds. However, Cordery believes these worries are starting to abate, a shift in sentiment that could lead to the government bond bubble deflating, or possibly bursting.

Only yesterday Bloomberg reported European Central Bank Governing Council member Axel Weber as saying the risk of Europe falling back into recession was "negligible".

Primary risk factors for corporate bonds include Japan style deflation and large bank failures, though Cordery does not expect either of these to become reality.

He is, however, "most worried" about inflation against a backdrop of central banks fanning its flames in an attempt to help deleverage their economies.

He warns: "If inflation goes above 5% then this would be bad for all bonds."

In terms of fund positioning, Cordery is looking for protection from rising bond yields by being overweight high credit spreading sectors and shorting German government bond futures. Overall though, he expects more modest outlook for total returns in 2011 than previous years.  

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