Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
You can access both of our platforms from a single Saxo account.
Whatever the ECB decides, the answer lies with short-term sovereigns
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Long-term yields are poised to rise further amid hawkish central banks, quantitative tightening, and the BOJ looking to exit the yield curve control. We expect 10-year Bund yields to test March highs at 2.76% in the upcoming weeks despite Germany being in a recession. At the same time, the German yield curve is likely to bull-steepen as investors position in the front end amid expectations of the hiking cycle to end. Within this context, short-term sovereigns offer a win-win solution. An investor buying 2-year Schatz today at 3.15% would still be in the green if rates were to rise by another 300bps throughout the next year, offering a decade-high yield and flexibility amid an uncertain environment.
With the ECB due to downgrade growth projections for this year and the next and increasing inflation forecasts for 2024, the case of stagflation becomes clearer. The big question is whether the ECB will continue to hike despite a recession in Germany and the Netherlands. Since the most prominent hawks come from these countries, a hawkish pause at this week's ECB rate decision makes political sense. Indeed, the ECB can enforce other tightening measures, such as ending reinvestments under the PEPP, without spooking markets.
A pause or a hike won't change the fact that Bund yields are poised to rise
The closer we get to the end of the hiking cycle, the more investors will position for the yield curve to bull-steepen. Therefore, in case of a pause, despite Lagarde maintaining a hawkish tone, yields will likely drop across maturities, particularly in the front end of the yield curve.
Yet, we do not expect the rally to last for long because selling pressure in the long part of the yield curve remains:
- US Treasury yields are still uptrending. Bunds are tightly correlated to US Treasuries, so if we see yields continuing to rise in the US, it's safe to expect the same to happen in Europe, too.
- The BOJ is looking to exit yield curve control (YCC). That means that Japanese investors will sell securities abroad to buy at home.
- Quantitative tightening (QT) adds upward pressure to yields. In July, the ECB ended reinvestments of redemptions under the Asset Purchase Program (APP) facility.
- As investors position for the yield curve to steepen, they will buy the front end and sell the long part of the yield curve adding to upward pressure to long-term yields.
Hence, we expect Bund yields to continue to rise to test resistance at 2.76%.
Short-term sovereigns offer an appealing risk-return ratio
Although we expect long-term yields to continue to rise, European sovereigns remain attractive.If you buy 10-year Bunds (DE000BU2Z015) at 2.65% today and hold it for one year:
- If the yield goes to 3.2%, you would lose -1.9%
- If the yield goes to 2%, you would gain +7.5%
If you buy a 2-year Schatz (DE000BU22023) at 3.15% today and hold it for one year:
- If the yield goes to 4.15%, you would still gain 2.18%
- If the yield goes to 2.15%, you would gain 4.15%
Yet, we favor the front part of the yield curve, which enables one to maximize returns while limiting duration. Indeed, if inflation surges again, central banks on both sides of the Atlantic might need to continue to tighten the economy despite a recession undermining their economies, putting upward pressure on long-term rates.
Looking at European sovereigns, Italian BTPS attract one's attention as they offer the highest yield in the euro bloc. They also provide an appealing risk-reward ratio:
If you buy 10-year Italian BTPS (IT0005544082) at 4.45% today and hold them for one year:
- If the yield goes to 4.95%, you would lose -2.95%
- If the yield goes to 3.95%, you would gain +12.11%
If you buy 2-year Italian BTPS (IT0005557084) at 3.86% today and hold them for one year:
- If the yield goes to 4.86%, you would still gain 2.87%
- If the yield goes to 2.86%, you would gain 4.78%
Latest Market Insights
Quarterly Outlook
-
-
Quarterly Outlook
Equity Outlook: Will lower rates lift all boats in equities?
Peter Garnry
Chief Investment Strategist
After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto... -
Quarterly Outlook
FX Outlook: USD in limbo amid political and policy jitters
Charu Chanana
Chief Investment Strategist
As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ... -
Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c... -
Quarterly Outlook
Commodity Outlook: Gold and silver continue to shine bright
Ole Hansen
Head of Commodity Strategy
-
Quarterly Outlook
FX: Risk-on currencies to surge against havens
Charu Chanana
Chief Investment Strategist
Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo... -
Quarterly Outlook
Equities: Are we blowing bubbles again
Peter Garnry
Chief Investment Strategist
Explore key trends and opportunities in European equities and electrification theme as market dynami... -
Quarterly Outlook
Macro: Sandcastle economics
Peter Garnry
Chief Investment Strategist
Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p... -
Quarterly Outlook
Bonds: What to do until inflation stabilises
Althea Spinozzi
Head of Fixed Income Strategy
Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ... -
Quarterly Outlook
Commodities: Energy and grains in focus as metals pause
Ole Hansen
Head of Commodity Strategy
Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...