Government Bonds: Recent Performance and Expectations
Government bond markets have enjoyed a solid run this summer, with significant price gains. However, these markets now face challenges due to bets on central bank rate cuts and the implications of a closely contested U.S. presidential election.
One of the key indicators, the 10-year U.S. Treasury yields, is set to decrease by almost 30 basis points (bps) by the end of August. This decrease represents the largest monthly drop of the year. Expectations for quicker rate cuts have driven this change, despite recent economic data easing fears of recession.
Global Bond Trends
In Germany and Britain, borrowing costs have also seen significant drops, suggesting a potential first quarterly decline since the end of 2023 for all three regions. Some investors are seeing this as evidence that "bonds are back" after suffering losses due to the surge in inflation and interest rates post-pandemic.
Investor Sentiments
Despite these gains, major investors believe the pace may slow down. Some, like Guillaume Rigeade from Carmignac, argue the current momentum for rate cuts isn't warranted, given economic indicators do not point towards a recession but rather a "soft landing." This term means the economy is slowing down gradually without crashing.
Federal Reserve and Rate Cuts
Bonds have benefited from assumptions that the Federal Reserve might cut rates by about 100 bps during its remaining meetings this year. This is double what was anticipated in July. However, this outlook contrasts with equity markets, which have remained relatively flat. Economists polled by Reuters expect fewer rate cuts than traders, pointing to a complex environment for investors aiming for substantial returns.
Upcoming Economic Tests
A major test for bond markets is the upcoming August U.S. jobs report. A weak report could increase expectations for a 50 bps rate cut in September, while stronger job data could reduce those expectations. Guy Stear from Amundi Investment Institute suggests assessing bond yield trends in early September before making investment adjustments.
Inflation and Market Conditions
The bond markets are also influenced by easing inflation. U.S. inflation expectations have fallen to their lowest in over three years. However, core inflation remains a concern. Carmignac's Rigeade warns that markets might be prematurely optimistic about inflation returning to normal levels.
U.S. Presidential Election Impact
The November U.S. presidential election adds another layer of uncertainty. A tight race between Vice President Kamala Harris and Donald Trump could impact fiscal policies and bond supplies. According to Flavio Carpenzano from Capital Group, high fiscal spending and bond supply are expected regardless of the outcome, potentially affecting longer-dated bonds.
Euro Zone Bond Market
Euro zone bonds, although having outperformed last year, have underperformed compared to U.S. bonds in 2024. With the euro zone’s economic growth lagging behind the U.S., there is potential for interest rate cuts to support its weaker fundamentals. Salman Ahmed from Fidelity International suggests that the euro zone needs more significant rate cuts due to its deteriorating economic situation.
