Update Bonds: Markets expect a rate cut in Europe
In a week characterized by a limited number of macroeconomic publications, we observe that markets continue to anticipate a rate cut by the European Central Bank (ECB) in December.
In contrast, investors seem uncertain about a potential rate cut by the Federal Reserve, a situation that has persisted since Donald Trump was elected.
This week was notable for statements by European Central Bank (ECB) members. Fabio Panetta, a member of the Governing Council, emphasized that the ECB should lower interest rates sufficiently to ensure they no longer hinder economic growth, arguing that restrictive monetary conditions are not necessary anymore. Madis Müller, another Council member known for his more "hawkish" stance, expressed similar views, albeit in a more measured manner, noting that inflation is moving in the right direction. In this predominantly wait-and-see environment, ten-year US Treasuries and ten-year Bunds traded sideways, remaining at around 4.4% and 3.3% respectively.
US investment-grade bond spreads have tightened to 78 basis points, close to their lowest level this year and well below the historical average. US election results provided a positive signal for investor sentiment regarding the US economy, thereby supporting corporate asset spreads relative to the risk-free rate. In Europe, we observe a similar trend, with spreads close to their lowest level this year at 102 basis points. This is supported by a disinflationary trend and expectations that the ECB will reduce interest rates in the coming months to stimulate the economy.
In riskier bond segments, the trend was similar and supported by the same factors. US high-yield spreads are near their lowest level year-to-date at 264 basis points, well below the historical average. European high-yield spreads remained stable in November, holding at around 310 basis points during the last few days. This is also well below historical averages and close to their lowest level year-to-date.
Following the election of Donald Trump, we believe that there are still many unknowns surrounding the magnitude of the impact of his policies and reforms. Despite yields in emerging-markets debt and high-yield bonds being attractive, we remain cautious due to the potential impact of higher rates on risky assets and valuations that we believe remain expensive. We therefore favour higher-quality bonds with relatively more attractive risk premiums.
Florian Bardy
