Analysis: The world’s largest bond markets are back in favour, as recession fears mount

Global indices are displayed on a screen on the trading floor of the New York Stock Exchange (NYSE) in Manhattan, New York City, US, August 19, 2021. REUTERS/Andrew Kelly

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LONDON, July 29 (Reuters) – One day you get out of the house, the next you go in: Collapsing global sovereign bond markets are back for better as fears of a global recession mount.

Government borrowing costs from Germany to France and Australia fell sharply this month, with 10-year bond yields down nearly 50 basis points each in July, and braced for their biggest monthly drop in at least a decade.

US 10-year Treasury yields are down about 80 basis points from 11-year highs in June, as decades of high inflation fueled expectations of an interest rate hike by the Federal Reserve.

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Steady inflation certainly means that not everyone is buying bonds and Friday’s data that showed eurozone inflation at another record high was a catalyst for new bond sales.

But there appears to be a shift as signs of slowing economic growth point towards a peak in official interest rates. This means that government bond investors who shunned in the first half of 2022 are regaining their allure.

German bond yields head for biggest monthly drop since 2011

Bond funds saw inflows of $3.6 billion in the week to Wednesday, the largest since March, Bank of America’s weekly analysis of inflows released on Friday showed.

Antoine Buffett, chief interest rate strategist at ING, said he wouldn’t be surprised if the German 10-year bond yield tested 0.5% in the coming months. It was at 0.9% on Friday and rose to nearly 2% in June.

“The tide has really turned, and bonds are back to behaving like recession hedges,” Buffett said.

Thursday’s data showed the US economy contracted again in the second quarter. Eurozone data on Friday showed that the bloc is holding up better than expected even though strong Germany is on the brink of deflation. Read more

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long game

Investors are increasing their exposure to long-term debt due to growth concerns.

It is beginning to increase the term, which is sensitive to moves in base rates, said Flavio Carpenzano, chief investment officer at Capital Group, which manages $2.6 trillion in assets.

“We recently reduced the duration of the underweight (positions) because Europe may go into a recession, in which case we want to have core assets like German bonds,” he said.

“From this perspective, we are gradually starting to increase the duration through German bonds in the 10-year part of the curve to protect the portfolio from a downside.”

Total returns, including capital gains and coupon payments, on Austria’s 100-year bonds rose 33% in July, according to Refinitiv data. But as with most very long-term debt, an investor who bought in at the start of 2022 would be down significantly so far.

The European Central Bank raised interest rates by 50 basis points last week and markets fully recovered in another big move in September. They now attribute a nearly 42% chance of raising another half a point.

Markets are pricing in the highest US interest rate of 3.2% by the end of this year and 50 basis points for rate cuts in 2023. Before the Federal Reserve raised rates by 75 basis points in mid-June, it had priced US interest rates at Peak by more than 4% in 2023 and cut the interest rate by a quarter point by the end of next year.

Earlier this week, the Fed introduced another rate increase of 0.75%. Read more

Seema Shah, chief strategist at Principal Global Investors, said the company has increased its exposure to US Treasury securities and investment-grade corporate debt due to recession risks.

“We expect a recession in 2023 and believe the Fed will start cutting rates towards the end of next year, and it’s hard to see a higher move in US bond yields,” she said.

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Investors said the outlook for European bond markets such as Italy is more complex, given growth concerns and political instability.

It is still underweight in Italian bonds, Carpizano of the Capital Group said.

Others said the drop in bond yields wasn’t a one-way bet as the fight against inflation was a far cry from the won – eurozone price growth hit a new record high of 8.9% in July.

“I feel the rise in interest rates is overstated,” said Tim Graf, head of macroeconomic strategy for EMEA at State Street.

“German 10-year bond yields at 0.9%, looking at the inflation picture, is not something I would like to have,” he said, noting that Bond yields could dip towards 1.25-1.5% by the end of the year.

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Reporting by Dara Ranasinghe. Additional reporting by Saikat Chatterjee and Sujata Rao; Editing by Tommy Rigory Wilkes and Thomas Janowski

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