Philippe NoyardGlobal Head of Fixed Income at Candriam analyzes the possible impact on bond markets of the policies of the central banks, and on the European scenarios.
Bonds, between central banks and elections
In the United States, growth continues to surprise to the downside, as shown by data for the month of June. In fact, both the ISM manufacturing and services reported values below 50, a rare event after the Covid pandemic. Likewise, thethe job market showed signs of weakness, with a modest decline in nonfarm payrolls and an increase in the unemployment rate to 4.1%. Finally, inflation data (including PCE) declined slightly. However, the Fed remained relatively dovish and dot plots still point to less than 2 rate cuts. We expect the first rate cuts to come in September.
How to orient yourself
The upcoming US elections – the experts explain – seem to be a significant source of concern both on the rates and volatility front. The outcome will in fact have a significant impact on the fiscal scenario of the United States and on the economy in general.
The general picture suggests privileging a long rate position (especially on the 5- and 10-year maturities). These segments continue to show better carry dynamics than the short-term part and remain a safe haven in the event of increased geopolitical risk.
Duration in euro: positive overall, negative for France
The ECB has lowered rates for the first time in five years and we expect two more cuts this year, the next one in September. In addition, estimates of inflation and growth for 2024 and 2025 have been revised upwards, although inflation expectations are still lower than in December 2023.
Overall, “we believe the disinflationary trend will continue, while the macro outlook will remain weak. Furthermore, technicals should be quite supportive, as flow dynamics are improving and the pace of supply should slow in the second half, while investors’ positioning on duration seems to have remained quite stable. Therefore, we maintain our slight overweight on euro rates and are looking for better conditions to take profit from our position.”
The French legislative elections ended with no party managing to secure a majority in Parliament. With the country’s fiscal deficit already under scrutiny (by rating agencies and for compliance with EU regulations) and in the absence of monetary support, French rates and spreads are likely to remain under pressure. We maintain our underweight on France, given the uncertainty over the possible formation of a government and subsequent fiscal policies.
On the non-core front, valuations remain decent and supply dynamics are now more favorable also for this segment, with the exception of Italy. We have opened a long position on Spain, where we see political stability and a significantly improved fiscal situation.
Euro credit: spreads still tight
We continue to maintain a neutral view on the investment grade asset class in eurosthe expert further underlines, explaining that “so far, the earnings season has been positive for European companies, with positive surprises significantly outweighing negative ones (in the estimates). Sector volatility in the month has been largely driven by events in France; some segments, such as insurance, banking, utilities, construction and media, have indeed suffered from a widening of spreads given their direct and indirect exposure to French risk. Conversely, some non-financial sectors have proven resilient due to a reduced direct exposure to France and/or idiosyncratic stories, such as basic materials, chemicals, food & beverage and technology”.
“Despite recent repricing volatility, credit markets have not seen any deterioration in primary demand or strong selling pressure on the secondary market, reflecting investor preference for credit and the resilience of the segment. However, spreads remain at very tight levels and do not appear to adequately price the risks.”
Resilient Fundamentals
We have revised slightly toI raise our view on high yieldn euro, negative to neutral. Fundamentals remain positive with most companies focusing on deleveraging to adapt their capital structure to a higher rate environment for longer. This segment has also corrected less sharply than IG since political uncertainty increased in France. Some cracks are emerging at the lower end of the ratings spectrum as some balance sheets are not sustainable in the new interest rate regime. Technicals remain strong with more rising stars than fallen angels and weaker credits downgraded to CCC or lower. High yield markets are shrinking in size and demand remains strong, especially in Europe. We remain negative on US high yield, where spreads are less attractive and fundamentals are weaker.
Emerging Markets: Profit Taking from Corporate Overweight
We remain neutral on EM sovereign debt. In our view, important issues such as positive inflation, central bank easing and fiscal consolidation appear to be baked into the risk premia of many credits. Some countries, such as Indonesia, are starting from relatively low debt-to-GDP levels and have sustainable plans to increase debt, investing in value-added activities and projects that expand the fiscal multiplier, such as free school meals for all. Others are not in the same position, so further debt issuance could contribute to spread widening over the course of the year, offsetting some of the gains on the d side from a decline in risk-free rates.
While we have a positive position on emerging market corporates, we decided to take profits as, after their strong run, spreads now look very tight in a global environment that is becoming less favorable.
