Analysis – World’s biggest bond markets are back in vogue as recession fears mount

bWai Dhara Ranasinghe

London, 29 July (Reuters) , One day you’re out and the next you’re in: The world’s battered sovereign bond markets are in favor again as fears of a global recession mount.

Government borrowing costs from Germany to France and Australia are down sharply this month, with 10-year bond yields down about 50 basis points in July and set for their biggest monthly declines in at least a decade.

The US 10-year Treasury yield has fallen nearly 80 basis points from an 11-year high in June as decades-high inflation fueled hopes of aggressive Federal Reserve interest rate hikes.

To be 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 fresh bond sales.

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

BofA’s weekly analysis of inflows, released on Friday, showed bond funds saw $3.6 billion inflows on Wednesday in the week, the biggest since March.

ING senior rate strategist Antoine Bouvet said he would not be surprised if Germany’s 10-year Bund yield tests 0.5% in the coming months. It was 0.9% on Friday DE10YT = RR and had risen to about 2% in June.

“The tide has really turned, bonds are back to behaving like a bearish hedge,” Bouvet said.

Thursday’s data showed the US economy shrank again in the second quarter. Euro zone data on Friday showed the bloc better-than-expected, although powerhouse Germany is on the edge of contraction.

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long play

Investors are increasingly investing in long-term debt due to growth concerns.

Flavio Carpenzano, investment director at Capital Group, which manages $2.6 trillion in assets, said he has begun to extend the period, which represents a sensitivity to moves in underlying interest rates.

“Recently we have reduced the period(s) of the underweight as Europe may enter a recession, and in that case we want a core asset like the German Bund,” he said.

“From that perspective, we began to gradually increase the portfolio through German bonds to the 10-year portion of the curve to protect the downside.”

Total return, including capital gains and coupon payments, on Austrian 100-year bonds AT0000A2HLC4 are up 33% in July according to Refinitiv data. But with the longest term loans, an investor who bought in early 2022 would be significantly less likely to pay year over year.

The European Central Bank raised rates by 50 basis points last week and in September the market paid full price for another big move. They now attribute about a 42% chance of an increase of one and a half points.

Markets are pricing in the highest US interest rate of 3.2% by the end of this year and a 50 basis point cut in rates in 2023. They had peaked US rates, just before the Federal Reserve raised rates by 75 basis points in mid-June. More than 4% in 2023 and only a quarter-point rate cut by the end of next year.

Earlier this week, the Fed raised the rate by another 0.75%.

Seema Shah, chief strategist at Principal Global Investors, said the firm has increased its exposure to US Treasury and investment grade corporate debt in view of the downside risk.

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“We anticipate a recession in 2023 and think the Fed will start cutting rates by the end of next year and therefore it is difficult to make a sustained move in US bond yields,” she said.

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

Capital Group’s Carpenzano said it remains underweight in Italian bonds.

Others said the drop in bond yields was not a one-off bet, as the fight against inflation was far from won – euro zone price growth hit a new record high of 8.9% in July.

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

“Looking at the inflation picture, the German 10-year bond yield at 0.9% is not something I would adopt,” he said, adding that Bund yields could move towards 1.25-1.5% by the end of the year. Is.

German Bund yields set for biggest monthly drop since 2011

Business activity weakening in major economies

US Yield Reversal Bearish Forerunner

(Reporting by Dhara Ranasinghe; Additional reporting by Saikat Chatterjee and Sujatha Rao Editing by Tommy Reggiori Wilkes and Tomas Janowski)

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