2013: The Year of the Twist?

“Bond yields have fallen last year, therefore it is unlikely that bonds will go up this year.” This is the same mantra that has been chanted by equity chauvinists for the last decade and every year they have been proven wrong. It is true that yields have fallen, but so have inflationary expectations, corporate gearing and demand for fixed income keeps on rising. Will 2013 repeat the performance of recent years?

If the bond markets sell off in 2013, it will have to be due to a significant change in demand. Supply is rapidly diminishing. The forecast is for the supply of Sovereign bonds to decline by 3% from USD 7.6T to USD 7.38T, according to Bloomberg. Demand seems firmly on a growth path. Foreign reserves continue to grow in the EMEA group of nations with the Sovereign debt their default investment. While China and others continue to channel funds towards their Investment Corporations, the flow is far below that of the increase in foreign reserves.

From a market dynamic standpoint, solid demand will underpin Government debt markets and yield curves in 2013. The interesting trade is what will happen at the short end of the US and European yield curves if their respective Central Banks take their foot off the liquidity pedal. This could see short rates rise while long rates remain firmly bid. 2013 could be the year of the Twist.