BLI: Shift in context for the bond markets

2 oktober 2023

A few months ago, we looked at the rise in interest rates that we have been experiencing for two years now. We set out the main reasons for this and its impacts on bond management. Containment, pro-cyclical economic policies, a resilient labour market and the war in Ukraine largely explained the rise in inflation.

After ten uninterrupted rate hikes by the ECB, inflation is now sharply declining for the region. Standing at 10.6% in October 2022, inflation for the eurozone is now at 5.2%. However, this remains well above the 2% target.

While it was almost -1% in September 2020, the yield to maturity shown by the benchmark German 5-year bond is now around 2.8%. This level hadn't been seen since 2011 during the European debt crisis (relating to the situations of Greek and Portuguese debts). Over the last two years, we have therefore seen a rise of almost 4% in the market for medium-term quality sovereign debt. Other asset classes have not been left behind: over the same period, the yield on the benchmark 5-year US Treasury bond rose from 0.19% to almost 4.6%.

As for riskier bond assets with a higher yield, we have investment-grade euro-denominated corporate debt offering a yield of almost 4% and emerging market debt displaying over 5% when denominated in euros and 8% in dollars. In fact, considering both technical considerations and an analysis of fundamentals, bond investments once again present a number of interesting opportunities. The only question that remains is whether key interest rates in Europe and the United States, in particular, will continue to rise.

The stakes are also evolving

Regardless, the situation we currently find ourselves in appears to be transient in many respects, both in the short and long term, depending on the considerations taken into account. The European economy is showing signs of weakening, with a significant slowdown in industrial activity, especially in Germany where unemployment has been on the rise for several months.

Across the eurozone, real estate markets are suffering from to tighter credit conditions. The slowdown in activity in Europe and China combined with the increasing cost of credit also affects companies. Some debt ratios are deteriorating, even if they start from a relatively solid base (increase in the level of indebtedness and deterioration of their ability to cover interest charges).

On the geopolitical front, the question of global leadership is becoming increasingly predominant. The BRICS summit in Johannesburg last August is a new manifestation of the questioning of the global balance that has prevailed since the fall of the Berlin Wall.

This Johannesburg summit, like other recent initiatives, takes us back to the Bandung conference of 1955, attended by various Asian, Middle Eastern and African countries. Bandung aimed to promote cooperation and neutrality in the context of the Cold War.

Nearly three-quarters of a century later, the rise of the BRICS, the stated desire of many states to de-dollarize their economy, China's ambitions on Taiwan, the questioning of the Sino-American relationship, the relocation of production chains outside of China in favour of other countries such as Mexico or Vietnam, and the redefinition of exchanges between China and Russia and their implications for other major emerging countries, are all developments that redefine the nature of global exchanges.

Moreover, recent climate disasters, such as the wildfires in Canada, remind us of the importance of taking measures to combat climate change.

Some of these changes are structural and will require time to materialize. Others generate opportunities in the short term in the public and private debt markets. In the face of these developments, there are both risks (persistent or worsening inflation, stagflation, deterioration in the fundamentals for various types of issuers, multiplication of conflict zones, etc.) and opportunities for investors (the possibility of a commodities supercycle, acceleration of the industrialization of certain economies, improving trade between nascent economic partners, ...).