We remain defensive on US Treasury bonds with a preference for short maturities.
Solid growth prospects and a possible ECB policy shift could drive core eurozone yields higher.
Further price pressure and higher yields abroad should push long-term rates further up in the UK.
In the emerging world, we would favour shorter-than-benchmark maturities with a preference for issuers offering spreads wide enough to act as a cushion.
Limited upside for core bond yields
"Solid growth prospects and a possible ECB policy shift could drive core yields slightly higher."
US government bonds. After a post-election rally in November 2016, Treasury bond yields have been sapped this year by lower inflation and delayed fiscal stimulus. Given the Fed is committed to hiking rates further and plans to shrink its balance sheet, yields are set to head north again. Growth remains steady and continued job creation will eventually translate into wage pressure. We remain defensive on US Treasury bonds with a preference for short maturities.
Eurozone government bonds. Bund yields turned positive in late 2016 and have risen since to just under 0.5%, well below the current YoY inflation rate of 1.6%. A stronger economic recovery has helped dispel deflation fears. However, the inflation outlook remains dull as highlighted by both the European Central Bank (ECB) and market expectations. Since its peak at 235 basis points last December, the yield gap with 10-year US Treasury bonds has narrowed and we believe more is to come. Solid growth prospects and a possible ECB policy shift could drive core euro yields higher. Since the eurozone periphery is enjoying stronger growth, further spread compression could mitigate the impact of rising core bond yields. However, much will depend on domestic factors.
Emerging debt back in favour
"Dollar- and euro-denominated emerging debt still offers some value carry-wise."
UK government bonds. A weaker pound has driven inflation higher through import prices. Meanwhile, the UK economy has begun to weaken as private consumption – a key economic driver – is being impaired by negative real wage growth and faltering consumer sentiment. The Bank of England stands between a rock and a hard place and a faction on the monetary policy committee is calling for a rate hike. Gilt yields have moved in sympathy with US rates so far. Further price pressure and higher yields abroad should push long-term rates up further in the UK.
Emerging debt. Abundant liquidity, a weaker dollar, low yields in developed markets and economic improvement in several countries have revived interest for emerging debt. With an average yield of 5.5%, investors remain attracted to those markets. Emerging spreads – EMBI Global – have stayed in a 300-320 basis point range since February and we believe a floor has been reached. Dollar and euro denominated emerging debt still offers some value from a carry perspective. However, our expectations for higher US yields would encourage us to favour shorter-than-benchmark maturities with a preference for issuers offering spreads wide enough to act as a cushion.
Sources: SG Private Banking, Bloomberg, 05/07/2017. Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations, and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.