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The bond market is being driven by two opposing forces: On the one hand, a recession is imminent both in the US and in Europe, which would argue for falling interest rates. On the other hand, central banks are raising key interest rates in combatting inflation “For long bonds, we are therefore beginning to see some potential”, says Carsten Gerlinger, Managing Director and Head of Asset Management at Moventum AM. “Short-term bonds, however, are susceptible to significantly rising yields.”

In recent weeks and months, the economic situation has continually deteriorated. As the US has been in a technical recession for two quarters, it threatens to slide into a classic recession. In Europe, a recession seems inevitable and is likely to be even more severe than on the other side of the Atlantic. China continues to be caught in the wake of its zero-Covid policy, while the real estate crisis is also simmering.

The dramatic rise in gas and electricity prices, which drove the inflation rate from 9.1 per cent to 10.0 per cent in September, is a particular burden faced by Europe. In the US, however, inflation may have peaked already – most recently, it fell from 8.5 per cent to 8.3 per cent. At the same time, inflation continued to gain breadth, with the core inflation rate – excluding energy and food – rising from 5.9 per cent to 6.3 per cent. “A sustained decline in inflation may not occur till there is a downturn in the labour market”, Gerlinger says.

The central banks are responding: According to Fed directors, the US central bank is willing to accept a recession to combat inflation. “It is therefore to be expected that the very restrictive Fed monetary policy course will continue”, says Gerlinger. The ECB’s monetary policy is following its US counterpart. “From today’s perspective, however, we consider the medium-term inflation targets of the central banks to be unrealistic.”

This means continued volatility for the bond markets. Long bonds are caught between high inflation and the risk of recession. The short-term segment in the US is clearly driven by the Fed’s monetary policy. “Against the backdrop of an expected recession, the long end is becoming more interesting in the US”, according to Gerlinger. “Volatility, however, is likely to remain high for the time being.”

After the spread on US high-yield bonds was around 600 basis points at the end of last quarter, it then narrowed to 430 basis points and currently stands at 543 basis points. For the time being, there is low refinancing requirement, since there are only a few upcoming maturities. Overall, there is good credit quality in the market, as weak companies have already defaulted in the past corona period. The spread on US corporate bonds now stands at 165 basis points. “While the yield level is fairly attractive at about 9.4 per cent”, Gerlinger says, “the spread currently fails to reflect the risk of recession in our opinion.” The segment remains vulnerable to rising interest rates.

There continues to be a risk of rising yields on euro government bonds, which the market fears to become a potential problem for peripheral countries. In addition, the energy crisis is significantly increasing the political risk in Europe. “The yield level on Bunds remains unattractive”, Gerlinger adds. “The ECB remains under strong pressure to raise key rates faster and more than initially thought because of high inflation rates.” There are selective opportunities in higher-yielding corporate bonds and high-yields from the eurozone. “While the current yield level at around eight per cent is quite interesting, it is our opinion that the spread does not reflect the risk of recession.”

Emerging markets are suffering from rising US interest rates. “We consider neither hard nor local currency papers to be interesting at the moment”, says Gerlinger.

All in all, he views the bond market split into two parts: “On the one hand, yields in the short maturity range are likely to continue to rise significantly following the latest statements by the major central banks. Accordingly, we are significantly expanding the segment by taking another floater position. On the other hand, the long end should gradually benefit from the prospect of a recession. In this maturity segment, we are therefore building up positions in the US bond market. Overall, we are reducing flexible positions.”

Additional information is available at www.moventum.lu