Global government bonds face period of temporary calm
Summary
Meaningful rises or falls in global government bond yields look unlikely in the near term as interest rates have peaked, but persistent inflation means rate cuts will likely be slow, analysts said.
Meaningful rises or falls in global government bond yields look unlikely in the near term as interest rates have peaked but persistent inflation means rate cuts will likely be slow, analysts said.
Money market forwards price in 42 basis points of rate cuts by the U.S. Federal Reserve, 65 basis points by the European Central Bank and 55 basis points by the Bank of England for this year, according to Refinitiv.
This is far less and much later than the multiple rate cuts which were anticipated at the start of the year.
“We are in the two rate-cut camp for the Fed, starting in September, and do not see much scope of a rally [in government-bond prices] from current levels," said Mohit Kumar, chief European economist at Jefferies, in a note.
Markets are pricing in a September rate cut by the Fed almost fully, leaving limited room for yields to fall, he said.
Jefferies recommends that investors exit any bets on higher prices—and consequently lower yields—for short-dated U.S. Treasurys or German Bunds.
The U.S. bank also sees limited scope for divergence between the Fed and the ECB, and expects ECB cuts in June, September and December.
A less volatile interest-rate outlook also makes duration strategies—those built on a bond’s sensitivity to interest rate hikes or cuts—less attractive for now, analysts said.
“The lack of pressure on [interest-rate] cuts (absent crisis/recession) makes us cautious on duration for now," Jamie Searle, rates strategist at Citi Research, said in a note.
Citi Research now forecasts the 10-year German Bund yield will fall to 2% for the fourth quarter of 2024, having previously expected a bigger fall to 1.85%. Ten-year U.K. gilt yields are forecast to fall to 3.4% versus a previous estimate of 3.25%. These yields are currently at 2.52% and 4.14%, respectively, according to Tradeweb.
Chris Iggo, chair of AXA IM Investment Institute and chief investment officer of AXA IM Core, is similarly cautious on duration strategies.
“Long-term rates (10-year government bond yields) are not likely to move materially higher than the range in which they have been trading this year…However, long-term yields are unlikely to move materially lower either," he said in a note.
Interest rates are at their peak and the risk of additional rate hikes has disappeared for now, but at the same time monetary easing will be slow because inflation remains above central banks’ target, he said.
Still, the current calm in bond markets might not last long given that inflation and interest-rate outlooks remain uncertain.
“For duration, while cautious near-term given the lack of pressure on [interest-rate] cuts, we still advocate patient longs, although raise our year-end yield forecasts a little," Citi’s Searle said.
Money markets expect the ECB to cut rates in June, followed by the BOE in August and the Fed in the autumn, according to Refinitiv.
