Update Bonds: Debt concerns are balanced

Much of the current market attention is focused on the shorter end of the yield curve, which refers to bonds with shorter maturities. This part of the curve benefits the most if the Federal Reserve (Fed) delivers a string of rate cuts. The Fed’s increasingly dovish tone, coupled with concerns about its independence, limited investor appetite for longer-term debt, and elevated long-term inflation expectations, is widening the yield gap between short- and long-term maturities. For now, this dynamic translates to lower yields on the short end of the curve, while longer-term yields remain relatively stable.

In Europe, there is growing speculation about whether Britain or France might be the first to require assistance from the International Monetary Fund (IMF). The 10-year French government bond (OAT) is yielding 3.48%, which is 78 basis point higher than their German peers. ABN AMRO Group Economics expects that this level will persist for the remainder of the year. A no-confidence vote in France’s parliament is scheduled for September 8th, raising the question of whether it could trigger new legislative elections. For now, financial markets are taking a ‘wait-and-see’ approach.

France’s fiscal outlook remains a concern. Public debt currently stands at approximately 114% of GDP and is expected to rise to 118% by the end of 2026, according to the European Commission. The EU has flagged several challenges for France: slowing growth, rising deficits and debt levels, higher taxes and political gridlock over proposed budget cuts. The French government must find a way to implement EUR 44 billion in spending reductions by 2026 to meet EU demands for fiscal balance.

Overall, governments worldwide are increasing spending, resulting in higher debt issuance and higher debt-to-GDP ratios. This marks a transition from what economists call a ‘savings glut’ towards a ‘bond glut.’ However, if governments can convince investors that economic growth is on the horizon and central banks remain committed to their inflation targets and keep their independence, these risks could be temporary. In such a situation, it is essential for politicians to clearly demonstrate their support for the government and central banks in fulfilling their duties.

In this uncertain environment, our preference stays with the higher quality bonds while avoiding long maturity bonds.