More accommodative monetary policies have curbed long-term sovereign bond yields, leaving bonds expensive. Given yields could pick up if – as we anticipate – economic data improves, we remain defensive on long-dated sovereign bonds, favouring short maturities.
Still favour short maturities
Attractive US 2Y as the curve remains flat The Fed surprised markets by announcing it plans no hikes in 2019 and only one in 2020 (according to its median projections), and that it will halt the rundown of its balance sheet by September. Policy rates are therefore unlikely to be a driver for any pick-up in long-term yields. Instead, the main lift for US Treasury yields could stem from a rise in term premium, i.e. the additional yield required by investors for holding longer-dated bonds. Shrinking safe-haven flows should also help. The difference between yields on short and long maturities is negligible and we prefer 2-year US Treasuries (UST) where expected returns are more attractive.
Hunt for yield in Eurozone with low-rate environment At its March meeting, the ECB postponed planned rate hikes to 2020 while also announcing a new round of long-term funding for banks. Core eurozone bond yields duly fell on various maturities. We do not think that yields on UST will widen further against Bunds, as monetary policy is no longer diverging. We expect 10-year Bund yields to edge up from zero towards 0.4% over the next twelve months. We expect growth to firm from mid- year which should push core bond yields higher.
Constructive view on Emerging bond debt
Brexit saga continues UK markets should remain volatile with the Brexit saga. Our base-case scenario is that the UK Parliament ratifies the agreement, averting a no-deal Brexit. “Soft” Brexit would ease business concerns and eventually boost domestic demand. An uptick in sterling would also dampen any upside inflation risks. In contrast, “hard” Brexit would mean a sharp drop in sterling and economic activity, leading to stagflation. We continue to expect one BoE hike in 2020 – the Bank will likely seek to temper strong wage-driven inflation - pushing 10-year Gilt yields back at 1.65%. This keeps us biased towards short-dated UK bonds.
Emerging bonds looking better The difference in yields (spread) between the EM Bond Index and US Treasuries has narrowed from a peak 400bp early this year to 327bp (still well above last year’s lows of 250bp). We believe there is room for additional spread narrowing. The macro backdrop is now more favourable to EM assets – Chinese stimulus has kicked in with additional slated fiscal boosts; the Fed’s pause should cap dollar strength; easier financial conditions for EM means the chase for yield will continue; and EM debt may continue to attract inflows, underpinning valuations.
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