Opportunities amid the bond market sell-off


On Monday, 10-year Bund yields climbed 14 basis points to 2.33%, the highest level since 2011, following a report that German Chancellor Olaf Scholz was ready to back the issue. of a common EU debt to deal with rising energy prices. While the German government later dismissed the story, bond markets remained under pressure. The yield on French 10-year OATs, which hit a post-2012 high of 2.91% on Monday, rose again on Tuesday to 2.93%.

The move was even more pronounced in the UK, with the 30-year gilt yield rising 29 basis points to 4.71%. Investors remain worried about the potential inflationary consequences of the UK government unveiling significant unfunded tax cuts at the end of September. Finally, the 10-year US Treasury yield rose 7 basis points to 3.89% on Monday and then to 3.96% on Tuesday, close to the highest level since the global financial crisis.

But the sale also offers opportunities, in our view. Rising yields have made investment grade bonds more attractive as defensive assets as recession fears continue to grow. Within government bonds, we see potential for US 10-year Treasuries to outperform French 10-year OATs:

The Federal Reserve is much further along in its tightening cycle than the European Central Bank. After increasing by 300 basis points already in 2022, the US central bank seems on track for another 75 basis point increase in November. The Fed is closer than the ECB to the terminal rate expected by the markets, currently around 4.7% for federal funds by next April. The ECB has so far only increased by 125 basis points. The consensus is that the ECB will struggle to raise rates given the threats to Eurozone growth, but with the fiscal taps open, the risk is that it will have to raise rates more aggressively.

Quantitative tightening is already underway in the United States, while the ECB is providing more support to the euro zone’s asset balance sheet. The Fed doubled the pace of quantitative tightening in September, so the impact on bond markets is at least partly priced in. ECB President Christine Lagarde has indicated that she does not seek to begin this process until the deposit rate has returned to “normal”. The Bank of England used its balance sheet to stabilize government bond markets. The ECB’s Transmission Protection Instrument (TPI), which aims to avoid excessive divergence in borrowing costs among member countries, involves further bond purchases. However, Eurozone yields are expected to rise and spreads widen to trigger the TPI and, with consensus views not expecting QT, any suggestion that it is being considered will also likely drive yields higher.

Superior liquidity in US Treasuries is attractive as economic and market headwinds continue. As the deepest and most liquid bond market in the world, US Treasuries tend to outperform in times of tight liquidity. We expect the Treasury market to continue to benefit from this safe-haven appeal under current conditions.

Thus, we favor a long position on 10-year US Treasury bonds over 10-year French OATs. This is also supported by the relative economic context between the two regions. In the Eurozone economy, fiscal support is increasing to cushion the economic blow as rising energy, food and commodity prices wreak havoc on the region. Meanwhile, the United States, as a net exporter of energy, does not face the same energy crisis as the Eurozone. To learn more about defensive strategies, click here.

Main contributors – Mark Haefele, Vincent Heaney, Frederick Mellors, Christopher Swann, Jon Gordon

The content is a product of the Chief Investment Office (CIO).

Original report – Opportunities amid the bond market sell-off, October 11, 2022.

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