Update Bonds: Motivation for buying bonds continues
Ten-year yields for US Treasuries and German Bunds have been trending higher since the end of December, with current levels around 4.67% and 2.55% respectively. They are closing in on the highs of May 2024, when levels were around 4.70% and 2.70%.
The rising trend can be explained by the higher premiums that government bonds are realising from investors due to less disciplined fiscal finances and the goal to continue to support domestic economies. Some countries are doing better than others, but current political trends make reforms difficult to achieve. Investors are therefore looking at economic growth expectations and inflation trends when investing.
Markets need to find an equilibrium in line with the credibility of government fiscal spending. And until this is found there could be more volatility. Governments continue to be challenged to implement reforms and reduce fiscal deficits.
Currently, the market expects that the US Federal Reserve will deliver fewer interest rate cuts in 2025 than had been expected. It is now believed that the 100 basis points in cuts seen in 2024 will not be repeated this year. Instead, just one or two cuts of 25-basis-points each is expected.
The European Central Bank could also deviate from its rate cutting trajectory. The market expects a reduction of 100 basis points; while we expect seven rate cuts in eight meetings, which could lead to a total of 175 basis points. The reduction is due to the weak state of the European economy and inflation developments.
But as we are now approaching US Treasury yields of 5% and 3% for Bunds, investors are reflecting on what these levels might mean for bond investing. In general, higher yields improve the motivation for buying bonds. (When bond yields fall, bond prices rise.) Our preference remains for quality government bonds offering exposure to the long end of the yield curve.
Our year-end 2025 forecast for German ten-year Bund yields is 1.45%. While this end-point may be aggressive, we stand behind the downward direction. This is based on our expectation of eurozone economic growth of 1.2% in 2025 and for inflation to decline to the target level of 2% (or less) by year-end.
Roel Barnhoorn