Four key questions for the bond market up to the end of the year
5 SEPT, 2024
By Mauro Valle from Generali Investments
September will be a month full of important events for debt markets, with the focus on the Federal Reserve meetings, where the first interest rate cut is expected to be announced, and the European Central Bank, which could follow up its pre-summer rate cut with a further reduction.
As these important dates for fixed income markets approach, Mauro Valle, Head of Fixed Income at Generali Investments, poses four key questions for fixed income investors.
Author: Mauro Valle, Head of Fixed Income at Generali Investments
The Federal Reserve's first rate cut, which will continue the monetary policy undertaken by the ECB before the summer, represents a major change in conditions for the bond market. We answer four questions that will be important for the future of bond markets in the coming months.
Have the uncertainties that have weighed on fixed income investment this year been dispelled?
The fixed income market, despite the volatility of the risky assets observed at the beginning of August, performed quite well from the end of June. The decline of interest rates, supported by expectations about future cuts by Central Banks, was positive for the performances of the government bonds, while the credit spreads are again close to the minimum of the year, after the widening registered in the previous weeks. In the next weeks the FED, to support the labour market, will start to with the cutting cycle, thanks also to a lower inflation level, and the ECB will cut again the official rates by 25 bps. The euro rates, given the environment of supportive central banks, a slightly weaker economy and inflation close to the 2%, could continue to decline. The credit spreads should be more sensitive to the performances of the risky assets, and in the case of negative momentum, as observed in August, spreads could widen. But on the other hand, we have to consider that the negative effect of larger spreads will be mitigated by lower rates. Our view about corporate bonds is still neutral, as they effectively contribute to maximize portfolio yields.
Is it time to take a larger position in longer-dated debt?
In our opinion, in these weeks, a portfolio could be exposed to interest rate risk or, in other words, to implement a moderate long duration exposure. The expectations are about lower rates in the next future, but we believe that the yield decline will be larger for the short - medium maturities of the yield curve, given the support that this part of the curve will receive by the cuts that the FED and ECB are expected to do in the next months. A fixed income portfolio, for the last months of the 2024, could implement appositive duration stance with an over exposure to the medium maturities.
What is the weight of fixed income in the portfolio?
In a balanced portfolio the fixed income component could be at a neutral weight but with a long duration. At the end of July -beginning of August, when the equity market collapsed around 10%, we have seen the Bund rates moving down up to 50bps, arriving in area 2.1% (from 2.6%); and, more or less, the same happened in the US market. We have to note that in an environment of clearly positive rates, in the moments of high volatility, the negative correlation is working again (equity down, bond up). A long duration stance is providing a natural portfolio hedge in case of risk-off phases. And this strategy can be implemented also for a fixed income portfolio that invest in higher risk bonds, as hybrids or high Yield bonds: a long duration stance can amortize the effects of wider spreads.
Which fixed income assets now offer the greatest return opportunities?
We think that a fixed income portfolio would be invested with a moderate long duration exposure. A good opportunity seems to be the expected steepening of the yield curve, that could show again a positive slope in the next months, after a long period of disinversion. And also, IG corporate bonds, despite the risk of credit spreads volatility, are always an area where to stay invested, especially if expectations are for lower rates in the next quarters. We believe that a fixed income strategy, with an adequate duration exposure, overweighting the medium maturities of the yield curve, and invested in a well-diversified portfolio of corporate bonds could perform well in the last months of 2024.
