Bonds: What to do until inflation stabilises

Bonds: What to do until inflation stabilises

Quarterly Outlook
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.


Market liquidity efforts and inflation remain key

In June, the Fed began to ease the pace of their Quantitative Tightening (QT), while the Treasury Department initiated US Treasury buybacks to enhance market liquidity. Despite these efforts, US Treasury yields are expected to remain elevated until inflation trends decisively return towards the 2% target. If the economy cools, support for US Treasuries may increase, but the Fed's reluctance to make significant rate cuts will likely counterbalance this demand. Meanwhile, Europe’s inflation rate has fallen below that of the US, allowing the ECB to potentially adopt less restrictive monetary policies, even though inflation remains above its target. 

This sets the stage for the upcoming quarter, with potentially growing divergence between the US and Europe. Although the interest rate differential between the two regions has widened significantly this year, forward swap markets predict these spreads will converge over the next three years, suggesting that increasingly divergent monetary policies are unlikely.  However, if Eurozone inflation continues to moderate relative to the US, interest rate differentials could return to pre-pandemic levels, leading to steeper yield curves in Europe.

Despite the widely anticipated and well-telegraphed rate cut in June, ECB policymakers appear hesitant to further diverge on monetary policy. They are remaining data-driven rather than committing to a specific rate path for the rest of the year. Consequently, we can expect short-term rates to remain stable, with yield curves steepening slightly as the European economy recovers and PEPP disinvestments begin in July. 

Strong demand to underpin corporate bonds as yields remain attractive

Despite a continuous deterioration in corporate bonds, investment-grade corporate bonds are likely to remain well bid as direction on inflation remains uncertain, and primary markets enter hibernation. As the Fed slows down QT and the ECB begins to cut rates, a further tightening of credit spreads is likely.

Similarly, high-yield corporate bonds are expected to remain underpinned throughout the third quarter. While spreads in the junk bond market are tight compared to historic averages, high-yield bonds have proven to be a crucial hedge against inflation over the past two years. With ongoing uncertainty about central banks' success in combating inflation, high-yield corporate bonds are anticipated to remain supported despite weakening fundamentals. In this environment, cherry-picking and bottom-up analysis become critical.

Investment implications

Performance in rate markets remains closely tied to the path of inflation. As the divergence between the US and Europe continues, it is important to maintain a cautious stance and limit duration exposure. Therefore, we remain positive on quality and maturities up to five years, while remaining cautious on credit risk and longer durations.

Developed markets' front-term rates have peaked in 2023, offering a win-win scenario for bond holders. For example, assuming a one-year holding period, the 2-year US Treasury yield would need to rise above 10.6% to result in a negative return, while the 2-year German Schatz yield would need to rise above 6% to provide a negative return over the same period.

Long-term rates remain vulnerable to the pace of inflation returning to 2% and a possible rebound in the term premium, especially as concerns over the sustainability of deficits grow. If US economic exceptionalism continues, ten-year US Treasury yields might rise to test 5% once again, dragging European sovereign yields higher, too.

Quarterly Outlook

01 /

  • Macro Outlook: The US rate cut cycle has begun

    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...
  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    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...
  • FX Outlook: USD in limbo amid political and policy jitters

    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 ...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    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...
  • Equities: Are we blowing bubbles again

    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...
  • Macro: Sandcastle economics

    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...
  • Bonds: What to do until inflation stabilises

    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 ...
  • Commodities: Energy and grains in focus as metals pause

    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...

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Trading in financial instruments carries risk, and may not be suitable for you. Past performance is not indicative of future performance. Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.