Analysis: The world’s largest bond markets are making a comeback as recession fears increase

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

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LONDON, 29 Jul. (Reuters) – One day you are out and the next day you are in: crisis-ridden global government bond markets are back in favor as fears of global recession rise.

Government borrowing costs from Germany to France and Australia declined sharply this month, with 10-year bond yields down about 50 basis points each in July and set for the largest monthly decline in at least a decade.

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

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Sure, sticky inflation means not everyone is buying bonds, and Friday’s data showing euro zone inflation at another record high was a trigger for selling new bonds read more.

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

German Bund yields are set for the largest monthly decline since 2011

Bond funds saw $ 3.6 billion worth of inflows in the week through Wednesday, the largest since March, according to weekly flow analysis released by BofA on Friday.

Antoine Bouvet, senior rate strategist at ING, said he wouldn’t be surprised if Germany’s 10-year Bund yield was 0.5% over the next few months. It was 0.9% on Friday and climbed to nearly 2% in June.

“The tide has actually turned, bonds are back to acting like hedges of recession,” Bouvet said.

Thursday’s data showed that the US economy contracted again in the second quarter. Euro zone data on Friday showed that the bloc held up better than expected, although mighty Germany is on the verge of contraction. Read more

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LONG PLAY

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

Flavio Carpenzano, investment director of Capital Group, which manages $ 2.6 trillion in assets, said he has begun to increase duration, which represents sensitivity to changes in underlying interest rates.

“We recently reduced the underweight duration (positions) as Europe could go into recession and if so, we want to have core assets like German Bunds,” he said.

“From this point of view, we have gradually started to increase duration through German bonds in the 10-year part of the curve to protect the portfolio from the downside.”

According to Refinitiv data, total yields, including capital gains and coupon payments, on Austrian 100-year bonds increased by 33% in July. But as with most ultra-long-term debt, an investor buying in early 2022 would have declined significantly year-to-date.

The European Central Bank raised rates by 50 basis points last week and the markets had fully discounted another big move in September. They now attribute an approximate 42% chance of another half-point increase.

Markets are pricing in a US high interest rate of 3.2% by the end of this year and 50 basis points of rate cuts in 2023. Just before the Federal Reserve hiked rates by 75 basis points in mid-June, it had priced the peak of US rates at over 4% in 2023 and only a quarter of a point cut in the rate by the end of next year.

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

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

“We expect a recession in 2023 and we think the Fed will start cutting rates towards the end of next year, so it’s hard to see a sustained rise in US bond yields,” he said.

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

Carpenzano of Capital Group said it remains underweight in Italian bonds.

Others argued that the downward movement in bond yields was not a one-way bet, as the fight against inflation was far from winning: euro zone price growth has risen to a new all-time high in the euro area. ‘8.9% in July.

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

“German 10-year bond yields at 0.9%, given the inflation picture, is not something I would like to own,” he said, noting that Bund yields could go back to 1.25-1.5%. before the end of the year.

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

Our Standards: Thomson Reuters Trust Principles.

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