ALTAIR’S CHIEF ECONOMIST STEPHEN ROBERTS FEATURES IN AFR

Bond rally chances ‘strongest of all’ in Australia as recession risk rises.

The sell-off in the bond market is a financial markets "blip" and not a sign of an upturn in global economic conditions - especially in Australia, where the risk of a recession has risen, helped along by surging house prices.

That's the view of Stephen Roberts, chief economist at fund manager Altair Asset Management, who believes that higher bond yields are a consequence of a market "that had rallied too far". All things being equal, a sell-off in the bond market points to better times ahead and a rally implies that economic conditions are getting worse. "The upward move in Australian bond yields is most clearly a blip in our view given that the risk of recession in Australia, although still small, is higher than it was a few months ago," Mr Roberts said.

The economist theorised that nowhere was the case for a bond rally stronger than in Australia. First-quarter growth was recorded at 0.9 per cent but was flattered by contributions from exports and undermined by flat domestic demand.

"Even the parts of domestic demand that managed to grow - household consumption and housing - look precariously supported in an environment of very low wages growth, a rundown in household savings and a housing price bubble inflating further in Melbourne and Sydney," said Mr Roberts.

"It is not possible to predict when the Melbourne/Sydney house price bubble will pop, but if it does over the next year or two coinciding with when the hole in growth from the decline in mining investment spending is at its deepest, the risk that Australia could experience a recession is quite high."

This prediction supports the case for further interest rate reductions from the Reserve Bank of Australia and a sell-off in equities led by bank shares. Bank stocks are down around 10 per cent for the past month. Meanwhile, the 10-year German bund yield on Wednesday night topped 1 per cent for the first time this year, up from just 0.05 per cent in April. In Australia, the 10-year government bond has surpassed 3 per cent from 2.3 per cent over the same period, and United States 10-year Treasuries have gone to 2.495 per cent from 1.9 per cent. This coincides with better than expected growth in the euro area, contrasted with what Altair argues are still challenging conditions ahead including the dependancy on further monetary stimulus from the European Central Bank and unresolved credit talks with Greece. "The European reason for rising bond yields looks very much like a temporary blip."

In the US, he argues that the market has got ahead of itself and there is no way that the Federal Reserve will have the means and specifically the kind of inflation to justify a higher Fed funds rate, indeed it will be "years" before it can get to 1.5 per cent. The rate of borrowing in the US is currently set at the zero bound but forecasters still tip the Fed to make it first hike in 2015.