In Europe, the situation is different: the Swiss National Bank (SNB) began its pivot towards an expansionary monetary policy last March. The European Central Bank (ECB) announced a first rate cut in June. But caution remains the order of the day in Europe and the United States: the ECB has not committed to a timetable for rate cuts, it is accelerating the reduction of its balance sheet and reaffirms that the conduct of its monetary policy will be assessed meeting after meeting, based on the latest inflation data.
While central bankers have recently revised their inflation forecasts upwards, it is clear that the cycle of lowering key rates in developed countries will be more measured than initially anticipated. In the United States, it is pushed back in time. But although delayed and progressive, the monetary pivot of central banks nonetheless remains a strong element of support for bond assets, which should continue throughout the year.
Global disinflation expected to continue
The return of price pressures at the beginning of the year led central bankers to revise their inflation forecasts. However, the latest data from developed countries have been reassuring and confirm that the rebound in inflation was only temporary. The global disinflationary movement should continue and support fixed income assets.
In the United States, after the rebound in the first quarter, consumer prices have recently returned to monthly growth rates more in line with a return of inflation to the Fed’s target. Inflation has resumed its downward trajectory. Prices of goods excluding food and energy continue to fall, and moderation of inflation in the services sector has returned. The components within this sector find more usual contributions compared to their history. Only the housing component remains dynamic, but should moderate in the future in view of the leading indicators published by real estate agencies. The evolution of producer prices has recently been more reassuring, as have the price components of the ISM purchasing managers’ confidence indicators.
More important for future price developments, the imbalances in the US labor market between supply and demand for jobs appear to have been resolved over the past two years. The impacts of the pandemic now appear to be behind us: the gap between the number of job openings and the number of people looking for work has narrowed. The relationship between the job vacancy rate and the unemployment rate has recently normalized and is returning to pre-pandemic dynamics. Both rates are now consistent with their long-term history. This implies that as job vacancies shrink, the unemployment rate should rise and in turn lead to further moderation in wage growth.
More generally, the gradual slowdown in domestic demand, which is particularly evident in consumption data, will help to ease pressure on prices in the United States.
In Europe, inflation continues to slow thanks to the fall in the price of goods. However, inflation in the services sector has remained relatively stable at a high level for several months. We also remain confident about the downward trajectory of European inflation, despite the emerging recovery in economic activity in the eurozone. On the one hand, leading indicators on wage pressures are pointing towards moderation, and on the other hand, since the European labour market is less flexible than in the United States, it is likely that the rebound in activity will not lead to immediate additional tensions. It is even possible that the European labour market will deteriorate moderately with a delay, following the stagnation in activity recorded last year.
These elements should be of a nature to reassure the Fed and the ECB in the conduct of their monetary pivot.
What are the consequences for the bond markets and our positioning?
In the wake of the rebound in inflation and the adjustment of investors’ expectations of key rate cuts, bond yields increased at the start of the year. However, the global disinflation process, combined with the monetary pivot of central banks and the soft landing of the American economy should allow bond yields to fall. Longer maturity bonds will be the first to benefit. Real rates are moving at historically attractive levels, and inflation expectations remain well anchored. In this context, we maintain our overweighting in bonds and have recently increased the duration of our bond pocket, with the exception of euro portfolios.
The increase in the duration of euro bonds is in fact delayed after the result of the French elections. Uncertainties remain high regarding the formation of a government in France and the latter’s ability to vote on a budget, while discussions around debt sustainability remain current. The American rating agency S&P Global Ratings recently downgraded the country’s sovereign rating, and the European Commission could prepare to open an excessive deficit procedure, so that France adjusts the trajectory of its deficit. The increase in rate spreads between French and German sovereign bonds could continue temporarily, and drag down the rates on sovereign bonds of peripheral countries in its wake.
Finally, we remain overweight on quality corporate bonds (investment grade) that will benefit from the general downward movement in yields. They offer attractive yield prospects, even compared to earnings yields on equity markets.
