Update Bonds: US elections loom
In the fixed income universe, sovereign rates have so far declined in July, in particular the shorter maturities and in both the US and eurozone. This is in line with our expectations and the consensus view, where the first rate cut by the US Federal Reserve is expected in September.
This comes with the acknowledgement that central bankers have seemed to have successfully tamed inflation after an aggressive hiking cycle.
The credit market was more in a wait-and-see mood in July, which is not surprising. There was no big negative news that would have provoked a sell-off. And, at the same time, the US economy, though slowing down, remains resilient. Credit spread valuations also remain expensive with not much more room for appreciation. This probably explains the stability in spreads, neither widening nor compressing, for the last couple of months. We choose to remain cautious, given the probable impact of higher rates on risky assets and on tight credit risk spreads. We therefore continue to favour safer high-quality bonds.
The US presidential election is the next big event expected to have significant implications for bond markets. After the first debate, it was clear that Donald Trump was taking the lead, but now that Biden has stepped out of the race, we’ll have to wait to see how things evolve. If the Democrats retain the White House, the economy will likely continue its current trajectory. But a Trump (Republican) victory could see lower growth and higher inflation. Given how tight and unpredictable elections can be, it will be a matter of following it closely until November.
With regards to our allocation, we retain a preference (overweight) for European corporate credits and a quasi-neutral position in sovereign bonds, favouring long-maturity core sovereign bonds, which should benefit from an attractive carry plus lower yields. We maintain a neutral bias towards emerging-markets debt and a negative stance toward high-yield bonds, given expensive valuations.