Horizon Q3│2024 - Bonds

In a nutshell

In the case of safe government bonds, investors are benefiting from the rise in interest rates, but price gains are not to be expected.
In the case of European corporate bonds, high-yield securities are back in play.
Improved economic prospects and yield premiums make local currency securities in emerging markets attractive.

Persistent inhomogeneity characterises the picture

The development of bonds in the current year continues to be any-thing but homogeneous. In view of rising (real) yields, the decisive factor was whether the resulting price pressures were counteracted by a narrowing of risk premiums (spreads). Segments with high credit ratings, such as first-class government bonds, performed weaker than riskier segments, such as corporate bonds, which benefited from falling spreads. We also expect the rest of the year to be heterogeneous. Where do we see opportunities?

Safe government bonds: no price impetus to be expected

In the second quarter, the price declines of safe government bonds on this side of the Atlantic widened slightly since the beginning of the year. In Germany and the eurozone, the recently faltering disinflation trend created a headwind, but price pressure also remains high in the US. The confidence expressed for this bond segment in the previous issue of "Horizons" was therefore somewhat premature in retrospect. Nevertheless, we expect positive performance over the next 12 months in the three currency areas we analysed. Falling key interest rates on the part of the major central banks will have a fundamentally supportive effect, with the European Central Bank (ECB) having already made a start with a move of -25bp in June, while the US Fed is not expected to start its cycle of interest rate cuts until December. Despite falling central bank interest rates, we do not expect yields on longer-term bonds to fall in our base scenario, meaning that investors should at best be able to realise the current interest rate. However, anyone wishing to benefit from the current yield advantage of UK or US government bonds must keep an eye on the exchange rate risk from a local perspective.

Bonds EN 1 — Time period: 18/06/2019–18/06/2024.

Tabelle Bonds EN — * Average, consensus as of 18/06/2024.

European high-yield bonds are back in the game

Our scepticism regarding the valuation of high-yield bonds has not been confirmed so far this year. Corporate bonds were among the beneficiaries of the brightening economic outlook. The segment received additional tailwind from positive capital flows and a very robust development on the new issue markets. Overall, this led to a decline in risk premiums across the board. Although the potential for a further decline in risk premiums appears limited, we are more constructive on high-yield bonds with current interest rates of over 6.7%. The ongoing economic recovery coupled with positive technical factors should provide further support. We continue to like securities from the more defensive investment grade (IG) segment. These offer an adequate yield level of 3.9%. The investment grade segment could receive an additional boost from further interest rate cuts by the ECB and the expected normalisation of the interest rate structure. In this market environment, bonds in the medium maturity segments, which make up around 45% of the IG segment, will benefit above all. The development of risk-free interest rates, which have been a burden so far this year, should also make a positive contribution in the future. However, this negative contribution has so far been fully or at least partially offset by the more positive assessment of credit risks.

Bonds EN 2 — Time period: 31/12/2023-17/06/2024; Source: ICE, own calculations

Emerging markets: clear opportunities in local currency bonds

Emerging market bonds also performed differently in the first half of the year. While local government bonds came under pressure due to the rise in US yields and the resulting strong US dollar, government and corporate bonds in the hard currency segment performed better. The superior performance of the high-yield segment was particularly notable. There are many reasons for this: some countries, namely Argentina and Ecuador, have better economic prospects since their change of government, while others, such as Egypt and Pakistan, have benefited from rescue packages from international lenders. The fundamental picture in the emerging markets has also brightened overall. Thanks to the slight recovery of the global economy, the export outlook for emerging markets has improved. In addition, the situation in China has stabilised, leading to a recovery in commodity prices. In this environment, the local currency segment is particularly very attractive. On one hand, many countries have successfully combated inflation through restrictive monetary and fiscal policies, leading to the highest real interest rates in a decade. Secondly, many countries are benefiting from the recovery in commodity prices, which is giving local currencies an additional boost. Against the backdrop of historical differences to US government bonds, the current yield level offers international investors interesting opportunities. Latin American countries in particular offer an additional yield of around 5.5% p.a. in this comparison. To summarise, it can be said that both fundamental improvements and attractive yield levels make local currency bonds in particular a promising segment. This remains our preference.

Bonds EN 3 — Time period: 31/05/2019-31/05/2024

Conclusion: corporate and emerging market bonds favoured

Regarding safe government bonds, British Gilts in local currency in particular are more attractive than German Bunds, although the exchange rate risk must be taken into account. In the corporate bond segment, we prefer medium maturities in the investment grade segment, which should benefit disproportionately from a gradual normalisation of the yield curve. However, high-yield securities are also attractive and should be included in the multi-asset context. Finally, local currency securities remain our favourites in emerging markets – they are the winners in an environment of high real interest rates and recovering commodity prices.