QE’s 'great flood' will avert bond liquidity crisis, says JPM’s Stealey

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JP Morgan's bond star Iain Stealey has brushed off concerns over a potential rush to the exit for bonds, arguing that there is still plenty of liquidity in the global financial system to support the asset class for some time.

With many commentators talking of a 'great rotation' out of bonds into what are perceived as more attractively valued equities, Stealey argues that for now, the actions of US and Japanese monetary policy makers will avert such a scenario.

Euro stars AAA-rated Stealey, who helps to manage over $14 billion in European and global bond mandates, believes that rather than a 'great rotation', the developed world's central banks had created a 'great flood' of liquidity that will ensure inflows continue into all asset classes, including bonds.

He told Citywire Global: 'The European Central Bank and the Bank of England may have stopped for now, but could start up again. There is still plenty of liquidity out there which supports all asset classes. The Federal Reserve and Bank of Japan are now pumping in a lot of liquidity which will take people out of cash and into all asset classes so money is still going into bonds.'

While Stealey concedes that developed world government bonds are at danger of capital erosion as inflation slowly rises, and that yields are  lower now than they have been in the past three years across corporate bonds, he thinks meaningful returns are still to be made on corporate bonds in particular.

'Corporate bond yields are lower but the spreads between corporates and governments yields is still attractive on a historical basis. Credit is still cheap versus government bonds although the beta trade of just buying credit and it going up in value is no longer there.'

In terms of his benchmark specific European Short Duration funds, Stealey continues to see value in corporates and financials over government bonds, especially with ten year German bunds potentially offering zero returns once inflation of around 2% is factored in.

'Government bonds have backed up year to date but that tends to happen in the first quarter of the year. We don't like core developed world government bonds as in real terms they are offering less than inflation but we don't see yields spiking any time soon with the Fedreal Reserve buying $85 billion worth of mortgage backed assets and treasuries. They will look to keep yields low to help growth and corporates to fund themselves.'

This view manifests itself in a 12% overweight to corporates versus government bonds in his Euro short duration fund, with 4% of that overweight coming from financials, although Stealey has been adding some Spanish sovereign exposure as he thinks yields still look attractive versus German bunds.

Within his strategic JPM Global Aggregate fund, Stealey and co-manager Jon Jonsson increased and then maintained their weighting to US banks over the past year as they see a positive backdrop for the sector.

'US banks had their bail out earlier than their [European counterparts] and all the actions the Fed is taking is benefiting banks.

In the  JPM Global Aggregate fund, Stealey has been adding to his emerging market exposure through both corporates and local currency.  

The fund now has no exposure to hard currency as the volatility of last year which drove investors into developed world currency and the US dollar in particular seems to have reduced for now.

'Last year EM currency was unloved as people focused on hard currency due to the volatility. Most of the [issues] were dollar-denominated but that spread has now contracted to 2.5% over treasuries.

The fund now has around 5% in local EM bonds split between Mexican, South African and Turkish bonds, with a further 5% in emerging market currencies split across China, India, Korea, Malaysia, Philippines and Russia.

'Peso-denominated Mexican bonds still give a 5.5% yield and they come with the upside of currency appreciation. We like emerging markets and think selective high yield and credit look relatively attractive compared to EM  government bonds.'