US Bond Market
In the current landscape, our MVST (Macro, Valuations, Sentiment and Technical) analysis framework is indicating a buy signal for bonds. The market is already pricing in a lower inflation rate, as the data presented continues to show during the last inflation releases. Projections also suggest a likelihood of rate cuts by the Fed in 2024, which is great news for the bond market and even for the stock market. Metrics like PMIs and new orders signalling contraction, both below 50, coupled with a forecast of below median economic growth, show weakness in the economy. However, it is not at the same level as Europe. Besides, amidst these challenges, the employment sector remains robust, providing a positive note. The overall stock market optimism during the year ended with a huge increase during November and December, which did diminish the allure of the bond market. This optimism might fuel further increases in the future.
Recent overall trends reveal a shift in investor behaviour with money flowing out of government bonds and into both high-yield (HY) and investment-grade (IG) corporate bonds. Notably, government bonds currently appear relatively expensive based on our analysis, potentially explaining the recent capital outflow. This shift toward corporate bonds mirrors the quest for better investment opportunities in the face of government bond overvaluation.
European Bond Market
The European Central Bank (ECB) is not inclined towards altering its strategy or reducing its balance. Yet, it's widely acknowledged that this stance might change in time. Meanwhile, short and medium-term bonds remain attractive as they offer good returns. For instance, the one-year German bond surpasses 3 per cent, outstripping the inflation rate and sustaining an inverted yield curve. Nonetheless, contemplating a shift in investment durations, particularly towards the middle and long segments of the curve, could be advisable. As the anticipated date for rate reductions draws nearer, the strategy of changing maturities to longer maturities allows for price appreciation of the bonds throughout 2024 and 2025. Persisting with investments in the shortest curve sections, amidst declining rates heightens the risk of reinvestment, making it difficult to replicate current returns on maturity.
While short and middle-yield curve segments present attractive yields due to historic highs and an inverted yield curve, transitioning towards longer durations seems prudent for long-term investors. This strategic shift anticipates sustained impending rate reductions and reduces reinvestment risks for investors.