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.

Richard Woolnough

Job Title: Fund Manager

Specialist Subjects: Government and corporate bonds

Likes: Running, cycling

Heroes: Mohammed Ali, Winston Churchill

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