Global bond markets staged a strong recovery in the first two weeks of 2023, fueling investors’ hopes that last year’s fixed-income rally is over.
Bonds are on course for their best January performance in more than three decades, fueled by a growing belief that inflation has peaked on both sides of the Atlantic.
The Bloomberg Global Aggregate index, a broad measure of global fixed income, has returned 3.1 percent so far this month. If it continues for the rest of January, it will be the biggest rise recorded in the first month of the year in records going back to 1991. The index has fallen more than 16 percent in 2022.
“It’s like night and day,” said Richard McGuire, a fixed income strategist at Rabobank. “Last year was historically bad, but there are all signs that this one is going to be much better for bond investors. Growth is slowing, inflation is slowing and we are confident that the peak in policy rates has already been priced in.”
Investors are betting that the Federal Reserve and the European Central Bank will slow this year in their efforts to tame rising prices, after both central banks helped roil debt markets last year by raising interest rates at an unprecedented pace.
At the same time, the specter of a looming recession could dampen the appetite for riskier assets such as stocks and instead draw large flows of money to the safety of highly rated government debt.
The gains – driven by a big increase in long-term government debt – are an early vindication for fund managers who in December favored bonds in their portfolios relative to other asset classes for the first time since 2009, according to Bank of America’s closely watched monthly. investor survey.
The 10-year U.S. Treasury yield fell to 3.46 percent, from 3.83 percent at the end of 2022, reflecting a rise in price. Germany’s 10-year yield, a benchmark for the euro area, fell from 2.56 percent to 2.10 percent in the same period.
Data in the first week of January showed euro zone inflation fell faster than expected last month as energy prices fell, helping to fuel the global bond rally. Meanwhile, confirmation this week that US inflation fell to its slowest pace in more than a year from 6.5 percent in December helped bolster the gains.
Investors have already begun the year betting that the Fed will start cutting interest rates later in 2023 as the US economy slows, despite repeated statements by central bank officials that borrowing costs may need to remain high for some time to combat inflation.
But even if rate cuts don’t materialize, some investors argue that falling inflation reduces uncertainty about further big hikes, which should favor longer-term bonds as well as riskier types of debt.
“The Fed is going to plateau eventually,” said Steven Abrahams, head of strategy at Amherst Pierpont. “At some point this year, large shifts in Fed funds will be off the table, which should substantially reduce interest rate volatility. And as rate volatility declines, risk assets, mortgage-backed securities and corporate credit should do well.”
There is also widespread hope that bonds will regain their traditional role as a safe haven against the coming economic downturn and should gain if stock markets suffer. That would be a break from 2022’s synchronized selloff when bonds fell, even as the MSCI All-World stock index fell nearly 20 percent.
“It’s very rare to have a big down year for both stocks and bonds, and last year was the first time since 1974 that you had both down,” said David Kelly, chief global strategist at JPMorgan Asset Management . “You usually bounce the next year, and I think that’s what’s happening now. It’s not the best of times, but it’s not the worst of times either.”
Others detect a hint of complacency in the resurgence of the bond market. According to Mark Dowding, chief investment officer at BlueBay Asset Management, the belief in markets that rates are nearing their peak and cuts are on the way is at odds with central banks’ newfound insistence that they will do everything they can to stem inflation. .
“We doubt that the relatively strong market conditions at the start of 2023 can be sustained for too long,” Dowding said, adding that he was “concerned about a narrative in markets that we don’t need to listen to central banks, since they don’t matter much”.
“It may seem complacent and we learned in 2022 how quickly underlying conditions can change.”
