More light than dark for European government bonds in 2024

With inflation expected to continue its downward trend and central banks potentially pivoting to a more accommodative stance, we believe the environment is ripe for European government bonds to thrive in 2024.  

The receding tide of inflation is a welcome development. As price pressures moderate, central banks should begin to ease their tightening bias, potentially leading to rate cuts around mid-2024. While the rhetoric in the coming weeks may remain cautious, emphasizing the need to keep inflation expectations anchored, the underlying trend suggests a shift towards a more dovish policy stance.  

Eurozone rates, after the downward movement observed from November, are likely to remain range-bound for a few more months, pending further confirmation of the macroeconomic scenario and inflation decline. With growth likely at its weakest stage, a recovery is expected in the second half of 2024 which should benefit European credit.  

The current inversion of the Eurozone yield curve reflects market expectations for future rate cuts. When the central bank does signal its intention to ease policy, the yield curve should steepen, with the 2–10-year Eurozone spread widening and a likely outperformance of medium-short maturity bonds.  

What are the Opportunities and Risks in 2024 ?

Given the favourable outlook, we think investors should exploit current elevated interest rates to optimise returns.  

We continue to consider Italian BTPs as a good way to maximize returns in 2024, aiming for yields of around 3.5% - 4.0%. At the same time, adding duration would be a useful diversification strategy in the event of a risk-off environment or increased volatility.  

In terms of European corporate bonds, there are good opportunities to accumulate carry and excess returns purely with high quality, well-rated instruments, particularly from robust financials and industrial conglomerates with businesses less correlated to the economic cycle.  

We believe 1-5 years maturities offer the best risk-return reward, but along the course of the year it may be wise to lengthen spread duration, to remain in safe territory.  

The risks to this proposition are the higher cost of debt or unexpected distress situations of companies that cannot easily refinance their debt through the usual borrowing channels.