US inflation dominant theme for global bonds

Rising inflation pressures in the USA will be a dominant theme for the markets over the next 6 to 12 months, says Salomon's Global Fixed Income head David Scott.

Friday, May 19th 2000, 12:00AM

"Fairly bearish" and "cautious" are how international investment manager Salomon is describing its view on global bond markets.

David Scott, London-based Manager, Global Fixed Income for Salomon Bros Asset Management, used just those terms in a presentation to Wellington advisers yesterday. And he believes that rising inflation pressures in the USA will be a dominant theme for the markets over the next 6 months to a year.

"Having gone through 12 months of significant interest rate rises in the UK, Europe, US and elsewhere, our view today really reflects that we'll be moving through a transition period over the next 12 months and that will be challenging," Scott said.

"The outlook of the central banks is in the US to fight inflation, in Europe to stabilise growth... But, looking out 12 months, we expect the central banks to have achieved what they set out to do."

Scott is touring New Zealand this week at the invitation of WestpacTrust as Salomon has managed the bank's international fixed interest trust for the past couple of years. In a quick overview of the bond markets, Scott said:

The EU economy was on track for stronger growth. " There's not really an inflation problem to worry about, and the level of combined confidence of consumers and industry is at its high for the last 15 years... This recovery has a much greater momentum than previous ones, so that Europe is recovering in a very balanced fashion."

In the US: "We're maybe already facing the start of rising inflation pressures... and there are pressures in the pipeline that we haven't seen since 1994."

As for Japan, "we suspect there's a recognition that growth is becoming more embedded. But Japanese growth is still dependent on public demand."

Scott said Salomon's base case scenario was for global growth accelerating over the year, leading to higher international yields. Yield curves would become flatter in Europe and the US but steeper in Japan, while the Euro would outperform the US dollar and the yen.

However, for investment strategy purposes, Salomon had factored in four key risk cases affecting that scenario. These are: a US financial market crisis (leading to lower bond yields and wider credit spreads), what they called "Goldilocks confirmed in the US (equity markets shortcutting the need for the Federal Reserve to put up rates, so a strong dollar and lower bond yields), an accelerating Japanese recovery, and a European Central Bank growth bias (weaker Euro, higher European yields).

That affected their thinking as follows:

	In the base case, excess returns are earned by:	Risk scenarios are hedged by:
Duration	Very aggressive global duration underweight position	Maintain underweight but reduce its size
Spread	Underweight in all regions (with a peripheral market bias)	Introduce a small long US Treasury position out of bonds
Slope	European steepening bias, Japanese market exposure to flattening	Keep the European steepening bias, but bias towards flattening in US market and move towards steepening in Japan