The real ‘AAA’ bull market

The flight to quality is in full flow. We’ve written a few comments recently covering goings-on in the money markets, and on Wednesday the huge demand for money market funds in the US meant that the yield on a three month US Treasury Bill saw its biggest one day fall since 1989. US interest rate futures are now pricing in two 0.25% US rate cuts by the end of this year, with another rate cut in Q1 2008.

What assets have performed well over the past month? Not surprisingly, assets with a lot of duration have had an incredible run as interest rate expectations have been pulled down sharply. Long dated gilts have returned over 5% in the last month, although year to date returns are still in negative territory. Interestingly, though, the dramatic spread widening of the past month has meant that long dated corporate bonds have hugely underperformed, returning just 2%. Long dated financials have performed particularly poorly on sub prime concerns, returning just 1%.

In line with this, I remain very cautious with regards to credit risk, and much prefer holding long dated AAA assets such as gilts and supranationals to get duration exposure. The market expects US interest rates to bottom out at 4.5% early next year, but history suggests the Fed tends to act very aggressively in the face of an economic slowdown. In the last two rate cutting cycles, it slashed rates from 9.75% to 3% in 1989-1992, and from 6.5% to 1% in 2000-2003.


The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Categorised as: ratings bond categories

Discuss Article

  1. Chris Cowell says:

    “In the last two rate cutting cycles, it slashed rates from 9.75% to 3% in 1989-1992, and from 6.5% to 1% in 2000-2003.”

    Thereby creating an impression of a free put risky assets, and the current credit situation – round and round we go. Can you discuss?

    Posted on: 17/08/07 | 12:00 am
  2. Richard Woolnough says:

    I agree. As I argued in a recent article, the roots of the current US housing market can be traced back to the Fed's decision to hold interest rates at 1%. The Fed's job, as with any central bank, is to intervene in the economy when imprudent lenders are hurt. The Fed has previously slashed rates to avert a full blown recession, and in 2000-02 it succeeded. In hindsight, where the Fed arguably went wrong was to take too long raising rates to 'normal' levels, resulting in a liquidity overdose.

    Posted on: 21/08/07 | 12:00 am

Leave a comment

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.