2024: The year for the Bond markets.
Last year we saw a massive spike in interest rates. Looking forward to 2024 we believe it may be a positive environment for fixed-income investors.
Using our analysis of the macro conditions and Fed intentions suggests that bonds will be a “Buy” for the year, thanks to the interest rate ceiling and evolving economic outlook. Recently, the Fed has indicated that they are on a pause and starting to discuss rate cuts with the dot plot showing 3 cuts in 2024 (-75bp) and an additional -125bp of cuts in 2025. Whilst the US is heading towards a rate-cut environment, cuts from the ECB may be further from this scenario. The risk is that inflation remains stubborn and could in turn increase, prompting a longer delay due to the markets already providing easier conditions; with 10-year US bond yields below 4% in December. However, the current environment means that investors (especially those managing books of assets and liabilities, such as insurance and pension companies) may look to secure the long-term real yields on offer currently –
10 Year - 1.97%
30 Year - 2.11%
(assumption is that inflation may hit 2%).
Currently, both the United States and Europe are in a cycle with low economic growth and a decrease in inflation. Consequently, interest rates are in their peak cycle. Forecasts indicate rate cuts for both economies in 2024. In the United States, these cuts could happen in the latter half of the year, signifying a positive opportunity to get good returns on short-maturity bonds. Contrastingly, in Europe, these rate reductions might happen earlier than initially projected due to the economy struggling, particularly the manufacturing sector. Therefore, it may be prudent to consider longer maturities in European bonds to mitigate the risks associated with reinvestment, considering the economy's continued challenges.
Where are we in the Global Macro Cycle?
An important consideration for any bond investor is an assessment of the Global Macro Cycle (shown below) and where we reside within such an environment. The consideration of where we are in any economic cycle is a fundamental basis of our overall investment analysis using our Macro, Valuations, Sentiment and Technical framework (“MVST”). Our analysis of this cycle shows that we have started to enter the phase where inflation is falling (from a high level) and growth (possibility of recession) overall is low with the central banks looking to maintain rates (or start cutting them). As such we consider this to be potentially the best moment for investments in bonds.
Using our analysis of the macro conditions and Fed intentions suggests that bonds will be a “Buy” for the year, thanks to the interest rate ceiling and evolving economic outlook. Recently, the Fed has indicated that they are on a pause and starting to discuss rate cuts with the dot plot showing 3 cuts in 2024 (-75bp) and an additional -125bp of cuts in 2025. Whilst the US is heading towards a rate-cut environment, cuts from the ECB may be further from this scenario. The risk is that inflation remains stubborn and could in turn increase, prompting a longer delay due to the markets already providing easier conditions; with 10-year US bond yields below 4% in December. However, the current environment means that investors (especially those managing books of assets and liabilities, such as insurance and pension companies) may look to secure the long-term real yields on offer currently –
10 Year - 1.97%
30 Year - 2.11%
(assumption is that inflation may hit 2%).
Currently, both the United States and Europe are in a cycle with low economic growth and a decrease in inflation. Consequently, interest rates are in their peak cycle. Forecasts indicate rate cuts for both economies in 2024. In the United States, these cuts could happen in the latter half of the year, signifying a positive opportunity to get good returns on short-maturity bonds. Contrastingly, in Europe, these rate reductions might happen earlier than initially projected due to the economy struggling, particularly the manufacturing sector. Therefore, it may be prudent to consider longer maturities in European bonds to mitigate the risks associated with reinvestment, considering the economy's continued challenges.
Where are we in the Global Macro Cycle?
An important consideration for any bond investor is an assessment of the Global Macro Cycle (shown below) and where we reside within such an environment. The consideration of where we are in any economic cycle is a fundamental basis of our overall investment analysis using our Macro, Valuations, Sentiment and Technical framework (“MVST”). Our analysis of this cycle shows that we have started to enter the phase where inflation is falling (from a high level) and growth (possibility of recession) overall is low with the central banks looking to maintain rates (or start cutting them). As such we consider this to be potentially the best moment for investments in bonds.
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.
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.
Bonds have performed well around Fed pauses.
Empirical evidence shows that upon the Fed ending their hiking cycle, any pause encountered before a cut usually lasts less than a year. This firmly puts us in contention for a cutting cycle to emerge in 2024. Interestingly, bonds tend to rise even without a rate cut. Historical patterns indicate that when the Federal Reserve reaches the peak of its rate-hiking cycle, the following period typically sees exceptional overall bond performance.
Percentage of returns after the interest rate peak:
Empirical evidence shows that upon the Fed ending their hiking cycle, any pause encountered before a cut usually lasts less than a year. This firmly puts us in contention for a cutting cycle to emerge in 2024. Interestingly, bonds tend to rise even without a rate cut. Historical patterns indicate that when the Federal Reserve reaches the peak of its rate-hiking cycle, the following period typically sees exceptional overall bond performance.
Percentage of returns after the interest rate peak:
Disclaimer
This commentary is for information purposes only and does not take into account the specific circumstances of any recipient. The information contained in this commentary does not constitute the provision of investment advice nor a recommendation, offer or solicitation to acquire (or dispose of) any financial instruments and/or services. Prior to making any investment decision investors should seek independent professional advice and draw their own conclusions regarding suitability of any transaction including the economic benefits and risks and legal, regulatory, credit, accounting and tax implications. The past performance of financial instruments is not indicative of future results and you may get back less than the amount you invested.
No representation or warranty, express or implied, is made by Dolfin Fund Management Ltd or any of its directors, officers or employees as to the accuracy, completeness or fairness of the information in this document and no responsibility or liability is accepted for any such information (save in respect of fraudulent representation or warranty).
This document may not be reproduced, redistributed or passed on to any other person or published, in whole or in part, for any purpose without the prior written consent of Dolfin Fund Management Ltd.
Dolfin Fund Management Ltd, a company registered in Malta (registered number C71750), authorised and regulated by the Malta Financial Services Authority (licence number IS71750)
Copyright © 2023 Dolfin Fund Management Ltd. All rights reserved
No representation or warranty, express or implied, is made by Dolfin Fund Management Ltd or any of its directors, officers or employees as to the accuracy, completeness or fairness of the information in this document and no responsibility or liability is accepted for any such information (save in respect of fraudulent representation or warranty).
This document may not be reproduced, redistributed or passed on to any other person or published, in whole or in part, for any purpose without the prior written consent of Dolfin Fund Management Ltd.
Dolfin Fund Management Ltd, a company registered in Malta (registered number C71750), authorised and regulated by the Malta Financial Services Authority (licence number IS71750)
Copyright © 2023 Dolfin Fund Management Ltd. All rights reserved