Bond Investors Bet on Rate Cuts as Central Banks Pause Hiking Cycle
Bond investors, who have suffered losses due to a record hiking cycle, are increasing their positions in anticipation of central banks cutting interest rates. This comes as the Bank of England (BoE) and the U.S. Federal Reserve pressed the pause button on raising rates, following the European Central Bank’s decision to pause its hikes. The bond market has struggled this year, with government bond indices experiencing a 2% loss after a 13% loss in 2022.
The bond market’s underperformance has surprised investors who expected inflation and economic growth to slow, leading to rate cuts. However, labor markets remained tight and central banks continued to express concerns about inflation. U.S. Treasuries, for instance, have recorded their longest consecutive monthly losing streak this century, resulting in higher yields.
However, hopes that the tightening cycle is over have led to a fall in government bond yields in the U.S. and Europe. Fund managers predict that the surge in bond yields will have such a significant impact on financing conditions that it will slow down the robust U.S. economy enough to merit rate cuts next year. Gregoire Pesques, CIO of global fixed income at Amundi, believes that a slowdown in Europe and the U.S. is already underway.
Investors see value in bonds despite rising interest rates and inflation. Higher yields erode the value of fixed-coupon debt securities compared to cash, making bonds less appealing. However, bond valuations have dropped significantly, leading investors to view government bonds as cheap compared to expectations for interest rates and inflation. Gurpreet Gill, macro strategist at Goldman Sachs Asset Management, noted that valuations now appear more attractive than a few months ago.
Despite these optimistic views, bond bulls are taking a risk, as inflation remains elevated, and uncertainty surrounding the conflict in the Middle East could lead to a spike in energy prices. Shamik Dhar, chief economist at BNY Mellon Investment Management, warned that risks to interest rates remain on the upside due to inflation being above target.
While the BoE has ruled out a quick easing, traders have moved their expectations of a rate cut in the UK to next August. Fidelity International and Invesco have both become more positive on developed market debt and turned towards UK gilts due to expectations of an economic slowdown prompting a more dovish BoE.
Investors will continue to monitor the actions of central banks and inflation trends to determine the future direction of bond markets and interest rates.
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More detail via Investing.com UK here… ( Image via Investing.com UK )