THE US bond yield goes in the opposite direction to what the market expected a month ago, despite the buying pressure on Tuesday permission from Vladimir Putin of the use of nuclear weapons in response to a long-range weapons attack on Russian territory. But the financial markets remain dominated by the arrival of Donald Trump at the White House. A month ago, there was no certainty that the Republicans would win the US elections nor that there was the possibility of a more inflationary environment for 2025. This reduces the price of US bonds and increases their profitability. However, the market expects bond prices to rebound by the end of next year, which would offer a profit to the investor of 5.5%. This would imply a return higher than that given by the coupon of this debt and higher than the expected return of the S&P 500 for the next twelve months based on its profit multiplier.
The year 2024 began with market confidence in a rapid and sharp downward adjustment of interest rates in the United States and the Eurozone. This caused the drop in bond yields sovereigns on the secondary market, which moves inversely to the price of these securities. Expectations have softened as the 150 basis point cut for the full year has been reduced to the 75 basis points the US Federal Reserve has achieved so far. In fact, the market already excludes that another cut could occur by 25 basis points in December, according to Bloomberg.
This resulted in a first opportunity for the investor to purchase US debt again with the aim of seeing a further decline in yields and an increase in prices. And, with the ten-year US bond at the current rate of 4.36%, a new opportunity presents itself according to projections from analysis firms. The expert consensus expects that the profitability of Ten-year US debt closes next year at 3.73% on average in the fourth quarter.
The gap between expectations and reality, of more than 60 basis points, forces us to witness buying pressure over the next twelve months, during which the Federal Reserve would reduce its interest rates by 75 points of basis, according to financial assets. OIS (Overnight inexed swaps used to calculate expectations of future rates). The nominal value of these ten-year bonds is 98.9 (at the time of their issue, their value was 100, in dollars because it is an American debt) and is expected to reach 104.47 by end of the year 2025. That is to say the increase. In the price of these securities would bring the investor a profit of 5.55%. “Given the market reaction so far, the risk-reward ratio on the 10-year U.S. Treasury seems reasonable, particularly given current geopolitical risks and the fact that the foreign policy setup under the new Trump administration is an unknown,” commented the fund director. Boutique Vontobel, TwenyFour, Felipe Villarroel.
If these ten-year bonds were bought today and sold in December next year, we would obtain a higher yield than even with the coupons that would be collected, more than 4.25%, but also than the company itself -even. Wall Street Stock Exchange. Provided that market expectations are met. The S&P 500 trades with a P/E (x earnings reflected in stock price) of 25.2 times. And the market consensus that reflects Bloomberg This multiplier is expected to average 24.3 times next year. In other words, the expected return on net profit (inverse of PER) will be 4.11% in the next twelve months.
The fact that the S&P 500’s ability to generate profits for each stock generates a return lower than the expected price change of a US bond, supposedly safer than stocks although not risk free, increases the attractiveness of sovereign debt. And the difference at the end of next year would be close to 145 basis points in favor of fixed income. This also happens with other shorter or longer maturities, but not with two-year US bonds. These securities will see their yield reduced by almost 100 basis points over the next twelve months, according to the market consensus reported by Bloomberg. But the price change would generate less than 3% profit for the investor.
While expected returns in the U.S. stock market trended downward as 2024 progressed, bond yields to maturity faced fluctuations that led to ten-year bond above 4.7% but also below 3.6% in September. And, although debt was sometimes higher than the inverse of the S&P 500 PER in terms of profitability, it is since October that the shift in position between the two and in favor of fixed income securities has occurred. Whether this trend continues will depend on the performance of the Wall Street index, earnings expectations, volatility in the fixed income market and the evolution of America’s debt to Donald Trumpamong others. “The U.S. deficit is likely to hit record highs outside of a recession, so it is important that 10-year Treasury yields do not exceed 4.5% to support the price-to-earnings (P/E) ratio or current multiple. S&P’s 12 month strategic objectives are under review,” says David Bianco, chief investment officer of DWS Americas.
On the other hand, there is a large dispersion of experts when it comes to defining where the ten-year US bond will be located at the end of 2025 (the average places it at 3.73% of the 48 experts consulted by Bloomberg). Companies like Goldman Sachs or Julius Baer predict that these securities will be at 4.1% in the fourth quarter of 2025. The ING group even sees it at 4.75%, which would imply erase all expectations of growing profitss due to rising bond prices and more losses. At the bottom, there would be opinions like that of Wells Fargo (3.5%) or HSBC (3.1%) which imply a greater drop in profitability than currently expected.
