Analysis: The world’s largest bond markets are back in fashion as recession fears rise

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

LONDON, July 29 (Reuters) – One day you’re out and the next you’re in: The world’s sovereign bond markets are back in favor as global recession fears mount.

Germany’s government borrowing costs to France and Australia have fallen sharply this month, with 10-year bond yields down around 50 basis points each in July and set for their biggest declines monthly for at least a decade.

US 10-year Treasury yields fell some 80 basis points from 11-year highs hit in June as decades-high inflation fueled expectations of aggressive interest rate hikes of the Federal Reserve.

Of course, persistent inflation means not everyone is buying bonds and Friday’s data showing Eurozone inflation at a new high was a trigger for further bond selling.

But a change seems to be happening as signs of slowing economic growth suggest a peak in official interest rates is approaching. This means that government bond investors shunned in the first half of 2022 are regaining their appeal.

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

ING’s senior rates strategist Antoine Bouvet said he wouldn’t be surprised if the German 10-year Bund yield tests 0.5% in the coming months. It stood at 0.9% on Friday and had risen to almost 2% in June.

“The tide has indeed turned, bonds are again behaving as hedges against recession,” Bouvet said.

Thursday’s data showed the US economy contracted again in the second quarter. Friday’s eurozone data showed the bloc holding up better than expected, although powerhouse Germany is on the verge of contraction. Read more

LONG GAME

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

Flavio Carpenzano, chief investment officer at Capital Group, which manages $2.6 trillion in assets, said it had started increasing duration, which represents sensitivity to movements in underlying interest rates.

“Recently, we have reduced the duration (positions) underweight because Europe could enter a recession, and in this case, we want to have core assets like German Bunds,” he said.

“From this perspective, we have gradually started to increase duration via German bonds in the 10-year part of the curve to protect the portfolio on the downside.”

Total returns, including capital gains and coupon payments, on Austrian 100-year bonds rose 33% in July, according to data from Refinitiv. But as with most very long-term debt, an investor who bought in early 2022 would be down significantly year-to-date.

The European Central Bank raised rates by 50 basis points last week and markets had fully priced in another big move in September. They now assign a roughly 42% chance of another half-point hike.

Markets are pricing in a US interest rate peak of 3.2% by the end of this year and rate cuts of 50 basis points in 2023. Just before the Federal Reserve raises rates by 75 basis points in mid-June, it had expected US rates to peak. to over 4% in 2023 and down just a quarter point by the end of next year.

Earlier this week, the Fed announced another 0.75% rate hike. Read more

Seema Shah, chief strategist at Principal Global Investors, said the company had increased its exposure to US Treasuries and investment-grade corporate debt given recession risks.

“We are forecasting a recession in 2023 and believe the Fed will start cutting rates towards the end of next year and so it is difficult to see a sustained rise in US bond yields,” she said.

Investors said the outlook for Europe’s peripheral bond markets, such as Italy, was more complicated given growth concerns and political instability.

Capital Group’s Carpenzano said he remained underweight Italian bonds.

Others said falling bond yields were not a one-way bet given the fight against inflation was far from over – eurozone price growth hit a new record high of 8.9% in July.

“I feel like the rate hike is overdone,” said Tim Graf, head of EMEA macro strategy at State Street.

“German 10-year bond yields at 0.9%, given inflation, is not something I would want to own,” he said, noting that Bund yields could go back towards 1, 25-1.5% by the end of the year.

Reporting by Dhara Ranasinghe; additional reporting by Saikat Chatterjee and Sujata Rao Editing by Tommy Reggiori Wilkes and Tomasz Janowski

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