Horizon Q2│2024 - Bonds

In a nutshell

After a weak start to the year for government bonds, UK local-currency bonds look set to recover.
In European corporate bonds, we avoid high yield, while bank bonds offer selective entry opportunities.
In emerging markets, falling interest rates make the local currency bond segment particularly attractive.

Heterogeneous markets offer varying opportunities

The bond year 2024 got off to a mixed start. Positive economic surprises have been met with headwinds in the form of rising yields, which individual bond segments have been able to counter to varying degrees. Heterogeneity is likely to characterise the remainder of the year, and while we do not retract our “The good times are not over” slogan from the previous issue of “Horizon”, we emphasise below that differentiation within the sub-markets under consideration is essential.

Safe government bonds: mixed outlook for the rest of the year

After the sharp fall in yields in the final weeks of last year, the past quarter has been characterised by a countermovement. However, the corresponding price losses have led to a positive message: the most difficult phase of the year is probably already behind us. As current yield levels have moved much closer to our forecasts, the outlook for the coming months is at least partly promising. For UK government bonds in particular, we see good opportunities for a clearly positive performance in the 10-year maturity segment. We are more cautious about German government bonds, which do not have as much to offer in the way of downside protection as their Anglo-Saxon counterparts, given their comparatively low basic interest rate (see chart below left). We continue to expect the major central banks to act in a supportive manner by lowering their key interest rates over the course of the year. In fact, we now expect the European Central Bank to take one more step than at the beginning of the year.

E-Bonds 1 — Time period: 18/03/2019–18/03/2024.

E Tabelle Bonds — * Average, consensus as of 18/03/2024.

Corporate bonds: hands off the high-yield segment

We were already very sceptical about the valuation of European high yield bonds at the end of 2023. While the investment-grade segment was still offering reasonable risk premiums, high-yield was already looking expensive on the back of a possible recession in Europe. However, the surprisingly positive economic data since the beginning of the year and continued solid corporate results mean that an imminent recession now seems less likely. This explains the positive start to the year for high-yield bonds (+1.8%), despite a significant rise in interest rates. Even though the economic outlook has improved, we remain sceptical given the historically high valuation of this sub-segment and prefer more defensive investment-grade bonds with reasonable yields of around 3.8%. Investors are currently concerned about the credit exposure of German financial institutions such as Deutsche Pfandbriefbank, as well as of savings banks and Landesbanken. As a result, risk premiums on European financial bonds have recently widened relative to non-financial bonds. Although we do not consider the situation for these institutions to be life-threatening at present, we would refrain from making any new commitments for the time being. In the short term, however, senior bonds issued by “national champions” such as France, the UK or Spain could offer interesting entry points.

E-Bonds 2 — Time period: 18/03/2019-18/03/2024, risk premiums in basis points.

Emerging markets: rate cuts support local currency bonds

Strong labour market data and recent higher-than-expected consumer prices suggest that the US central bank could leave its key interest rate at the current level for longer than had been expected at the start of the year. The number of interest rate cuts priced in by the market for 2024 has been revised from six at the time to three at present, and the US government bond curve shifted upwards by 25 to 35 basis points as a result. In response, the local yield curves in numerous emerging markets also came under pressure. Is the latter fundamentally justified? A look at the inflation figures for emerging markets that raised interest rates very early on provides no evidence of this – on the contrary, the flattening of inflation in emerging markets is a clear trend. While in December just two of the ten countries we analysed in detail from this perspective had already seen inflation fall to the respective central bank target, this figure had already risen to four in January. From a fundamental perspective, local interest rates should therefore fall rather than rise, which would support bond prices. In fact, some emerging-market central banks have already started to cut interest rates, including Brazil, Chile, Poland and Hungary. In Central America, Mexico should soon follow suit. We therefore currently see very attractive opportunities for investors looking to benefit from interest rate cuts in emerging markets. We remain optimistic about local currency bonds in particular and, from a regional perspective, favour those countries where real interest rates are high and the economy is fundamentally on the right track. Furthermore, we do not expect any negative surprises in connection with the forthcoming elections in some emerging markets, which means that there should be no disruption from this side either.

E-Bonds 3 — Time period: 01/01/2021-29/02/2024, Source: Bloomberg

Conclusion: it is worth taking a closer look

There are opportunities and risks in all three of the segments discussed above, so it is worth taking a closer look. In the safe-haven government bond market, UK gilts in local currency are particularly attractive, while German bunds and US securities are less so. If you want to invest in corporate bonds, we believe you should focus on the investment-grade sector. National banking champions also offer interesting opportunities. Also, in emerging markets, it is local currency securities that are benefiting from the central banks' interest rate pivot – a trend that should continue.