The market has been forced to live with an anomaly in the prices demanded for fixed income securities for years. Investors were demanding higher yields on some short-term debt assets than on long-term ones. Why? Essentially because such sharp increases in rates anticipated a sharp economic deterioration in the near term, which implied a higher risk for the first bondholder than for the most patient.
This anomaly has occurred in virtually all curves of major Western economies if we consider the relationship between secondary market yields on 2- and 10-year bonds, although at different durations as well. Anything other than the curve going from less to more profitability with longer durations is illogical in a perfect market since it is understood that in the longer term there is more uncertainty about the recovery of investment.
SO, In recent months, the situation has reversed. as expectations have grown for rate cuts (which have already started) in an environment of soft landing for the economy. Earlier this month, the curve was divested in the UK and the US, perhaps the biggest global economic benchmark in this sense. And this week, the German did the same, for the first time since November 2022.
Central banks have not only started to cut rates after two years of monetary contraction, but they are also charting the path to follow in the coming months. The market expects between 50 and 75 points less before the end of the year from the Fed and the ECB and that this normalization will continue during 2025, until leaving them at historically normal levels, in line with the achievement of the objectives of getting inflation back on track. .Idea 2%.
Short-term debt is the most sensitive to changes in rate expectations and the one that positions itself most quickly according to what is expected of central banks. “The steepening of the curve is a global phenomenon that could be even more pronounced in the United States,” explain Andromeda Capital Management. Historically, when the curve inverts, it is an early sign of recession, which has not been the case so far in this last stage. “What the curve is telling us now is confidence in the ability of central banks to support economic expansion for longer,” they emphasize at JP Morgan.
In theory, the ECB’s sole objective is price stability, while the Fed’s mandate is to protect the labor market and, by extension, economic growth. However, the latest indicators of activity on the Old Continent have been hard to ignore and, even though inflation has not yet reached its 2% target, the market is anticipating a gradual decline in the price of silver on both sides of the Atlantic, as well as one in the United Kingdom. In Japan, the view is the opposite and, after many years of zero rates and non-existent inflation, the situation is now starting to rebound and the BoJ has already carried out the first rate hike in this case, which led to the rise of the yen and the stock market correction in early August.
“The Fed is very aggressive when it comes to normalizing its monetary policy, which has been restrictive so far,” BlackRock points out. “This is why bonds can now play a very good role in a portfolio,” they add. From La Financière de l’Échiquier, they explain that “this return to normal has a virtue, which is to give investors room for maneuver in terms of asset allocation, since bonds can once again play their role as a safety cushion at a given time.” a period when doubts about the solidity of the economy could increase.
Only Switzerland remains
Within the major world economies, the situations are different. Faced with sudden increases in inflation and interest rates in powers like the United States, the United Kingdom and the eurozone, other economic areas have had other tools or contexts. One of them is Swiss, which came from negative rates of -0.75% and only had to put the price of money at 1.75% to control inflation. In fact, he has also already started his particular cuts, of 50 points, which has flattened his curve but has not yet completely corrected it. The 2 and 10 years, in this case, offer the same profitability.
In some large emerging countries, such as Brazil and Mexico, the interest rate is 10.75% and their curves have not even inverted. For its part, in China, where the 10-year bond yields barely exceeds 2%, it announced this week a new stimulus plan to revive the growth of its economy and not fall into the stagnation of prices that Japan has experienced over the last decade.
