Government bond markets, which have experienced a robust summer of price gains, now confront significant challenges as investors reassess their expectations for swift central bank rate cuts, slowing inflation, and the impact of a closely contested U.S. presidential election.
In August, benchmark 10-year U.S. Treasury yields are on track to decrease by nearly 30 basis points, marking their largest monthly decline this year. This drop is driven by expectations of quicker rate cuts, despite recent economic data that has eased recession fears triggered by the last U.S. jobs report.
Germany and Britain have also seen significant declines in borrowing costs since July, setting up all three regions for their first quarterly drop since the end of 2023. It's important to note that bond yields move
inversely to prices.
For many investors, these trends suggest that bonds are making a comeback after suffering losses during the post-pandemic surge in inflation and interest rates. Government bonds returned just 4% globally last year after a 15% decline over 2021-22, and they have posted a 1.3% return year-to-date.
However, major investors are increasingly cautious, predicting that gains may either slow downsignificantly or be overestimated. "We have many indicators showing that the economy is not falling into a recession. We are just in a soft landing," said Guillaume Rigeade, co-head of fixed income at Carmignac. He remains skeptical of the rapid shift towards a rate-cutting cycle, especially for longer-dated bonds on both sides of the Atlantic.
Bonds have gained momentum based on expectations that the Federal Reserve will reduce rates by about 100 basis points over its three remaining meetings this year, potentially including one 50-basis-point cut—double the expectation from late July. Traders have similarly increased their bets on central banks like the European Central Bank.
This outlook contrasts with equity markets, which have seen returns flatten since mid-July, while global government bonds have returned around 2% over the same period. Additionally, economists surveyed by Reuters anticipate that the ECB and the Fed will implement one fewer rate cut than traders currently expect this year.
These discrepancies underscore the complexity of navigating the government bond market for the remainder of 2024, as investors seek to secure meaningful returns in an increasingly uncertain environment.