David Roberts

What if the fiscal forecasts are wrong?

David Roberts

Government bond yields in developed economies reflect – among other things – countries’ levels of debt today and in the future. If the market’s expectations of fiscal spend and budget surpluses and deficits are not proved correct, this can have a material impact on bonds.


Five year projected gross debt across advanced economies 


Recent analysis of IMF data by Bloomberg looked at which countries have headroom to spend and which are less able to open up the fiscal taps. The chart shows that Germany, Canada and Sweden are expected to run budget surpluses and reduce their debt:GDP ratios, which should in theory make them more creditworthy and support lower yields for their bonds.


On the other hand, the US stock of debt is forecast to grow at a faster pace than its economy, reflecting the impact of the giveaway Trump enacted in 2017/2018. As a result of this perceived deterioration in US creditworthiness, treasury yields have already risen from record lows and stand at a big premium to European yields.


But what if we were to challenge some of these fiscal forecasts? If, for example, Germany, Canada and Sweden were to defy the IMF projections and increase their fiscal spend – perhaps just to the point of balancing their budgets – this could leave their bonds looking vulnerable to capital losses as supply kicks in and yields rise. Equally, were the US fiscal stimulus to spur growth by more than expected, then the IMF’s forecasts could look too pessimistic, possibly putting pressure on bond prices globally.


Since launch, our strategic funds have largely been long US bonds relative to G7 economies such as Canada and Germany (Sweden does not have a liquid enough futures market to permit a short). We think there is a chance governments will increase fiscal spend to maintain growth, especially now that monetary approaches such as quantitative easing (QE) and zero interest rate policy (ZIRP) seem to have run their course. We have therefore favoured economies – such as the US – where stimulus has already taken place and bond prices have fallen compared with other countries.


For a comprehensive list of common financial words and terms, see our glossary here.


Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, February 24, 2020, 11:39 AM