- We remain defensive on US Treasury bonds with a preference for short maturities.
- Stronger growth and a likely shift in ECB policy should lift core eurozone yields.
- UK yields are set to move sideways with the upward pressure from abroad mitigated by weaker growth.
- Emerging debt still offers better yields. We would focus on below-benchmark maturities to hedge against a rise in US bond yields.
Core bond yields to inch up
"Solid growth prospects and a possible ECB policy shift could drive core yields slightly higher."
- US sovereign bonds. Long-term yields eroded this summer with fading hopes for Trump measures and weak inflation weighing on market sentiment. They have since crept back up thanks to a positive underlying trend and further improvement in labour data. Any sign that the promised tax reform will be adopted by Congress in early 2018 would drive them even higher and the reduction in the Fed balance sheet will add to the upward pressure on medium- and longterm yields. We remain defensive on US Treasuries with a preference for short maturities.
- Eurozone government bonds. German Bund yields have recovered from their dip into negative ground in summer 2016 but remain low because of ECB bond purchases, Bunds’ safe-haven status and the lack of drive from US yields. Moreover, scarce issuance of core bonds will continue to cap yields. However, their levels seem excessively low, well below nominal growth. Several factors should now drive them higher: 1/ a potential pick-up in inflation in some areas of the eurozone; and 2/ a gradual reduction in asset purchases as signs of economic recovery become more widespread. Core bond yields could edge up in sympathy with their US equivalents. We expect further convergence in the region, with a tighter spread between peripheral and core bond yields. Domestic factors will remain in the driving seat. However, improving fiscal positions thanks to stronger growth may lead to further spread compression overall. We still see value in selected peripheral bonds but would focus on shorter maturities in a context of rising yields.
Emerging debt offers opportunities
"Dollar- and euro-denominated emerging debt remains in a sweet spot going forward."
- UK government bonds. Sterling has recovered in anticipation of an imminent Bank of England rate hike. However, we don’t buy it given inflation has already peaked and is set to be driven lower by weaker growth. Both drivers are pointing in opposite directions but the mild rise in rates we expect overseas – and above all in the US – could drive long-term yields a little higher in coming months.
- Emerging market debt. Emerging bonds have been among top performers in fixed income mostly thanks to a weaker dollar and easy financing. With US interest rates still very low despite some normalisation, investors have been attracted by emerging bonds’ higher returns. Spreads have narrowed further, recording a new low since mid-2014 just above 300 basis points. However, emerging market yields still look high enough and the global economic recovery increases the chances that issuers redeem their debt. Emerging bonds have recorded positive net inflows since early 2017 and there is more to come. However, selectivity is advised – less creditworthy countries such as Turkey and Ukraine have recently tapped global financial markets to take advantage of yield thirst. We would favour high-yielding issuers supported by the ongoing recovery and with a robust credit profile (small current account deficit and/or high level of foreign reserves).
Sources: SGPB, Bloomberg, 05/10/2017. 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.