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A bond market bruising

market snapshot

6 October 2023 |
The yield on global government bonds reached multi-decade highs this week, as markets adjust to a sustained period of higher interest rates.

Fast reading:

  • On Monday, US 30-year bond yields climbed to 4.95% – their highest level since 2007 – while the benchmark, the 10-year yield, rose to 4.8%.1
  • Across the Atlantic, UK gilt yields followed suit and reached their highest level in 25 years.
  • The sell-off in global bond markets comes amid growing concerns central banks will hold interest rates higher for longer.

In the US, September’s stronger-than-expected jobs data raised concerns the Federal Reserve (the Fed) will commit to higher interest rates in a bid to bring down inflation. In Europe, meanwhile, the direction of travel for rates remains equally unclear, with policymakers at the Bank of England (BoE) and the European central bank (ECB) due to meet again at the end of the month.     

The bond sell-off has eased marginally since the beginning of the week, with yields in the US and Europe falling on Wednesday. However, analysts warn that recent tremors in the market could expose fragilities within the financial system.

Lewis Grant, Senior Portfolio Manager for Global Equities at Federated Hermes Limited, notes that feelings of uneasiness in the historically stoic bond market have filtered down into equities, with the current environment drawing parallels to market meltdowns of decades gone by.

“As yields have shot up, expectations of a structurally different market have faded and now we are beginning to see the reality of a higher interest rate environment stunting equity growth. And yet, the Nasdaq’s recovery off the back of weaker-than-expected jobs data shows there is still potential for optimism in growth stocks, with mega caps continuing to lead the way.”

Different environments are fostering opportunities in value and growth, Grant notes – further compounding the uncertainty.

“While in the US we have seen mega-cap growth benefitting from a flight to quality, value is winning in Japan and Europe as cheap companies are beginning to shine. This trend accelerated throughout the summer but has become volatile in recent days following the week’s turmoil in the bond market,” he says.

Figure 1: US bond yields reach 16-year high

Deborah Cunningham, Chief Investment Officer for Global Liquidity Markets at Federated Hermes, considers what the ‘higher for longer’ narrative could mean from a liquidity perspective.

“While rising rates tend to benefit liquidity products, the ever-shifting simplified employee pension (SEP) has often blocked entire sections of the Treasury yield curve from useful trading. That is occurring now. If you believe, as we do, that rates will climb further, value is hard to find along the yield curve. The yields are simply not high enough. Thankfully, the various prime curves have tracked the Fed better, one of the reasons for the continuing flows into retail prime funds,” she says.

While Cunningham accepts the central bank’s current message of ‘higher for longer’, she believes a month’s worth of data could do enough to tip the scale.

“At present, we expect a quarter-point hike in November and don’t envision easing to take place until 2025, or late 2024 at the earliest. The US economy has been exhibiting signs of slowing but not rolling over. Consumers and workers remain in positions of strength, and goods and services sectors are hanging in there. Inflation is falling, but the closer you get to the endzone, the harder it is to advance. The game is far from over.”

Inflation is falling, but the closer you get to the endzone, the harder it is to advance. The game is far from over.

Elsewhere this week…

The World Bank downgraded its growth forecast for China next year, with other developing economies in Asia also expected to suffer.

The institution revised its previous forecast of 4.8% down to 4.4% – pointing to China’s property crisis, rising levels of debt and a slow-moving post-pandemic recovery as causes for its verdict.2

The region is projected to experience the slowest pace of growth since the 1960s – but China, the world’s second largest economy, is cited as the main barrier to progress.

Figure 2: GDP growth and 2023-24 forecast of East Asia & Pacific (excluding high income) (%)

For further insights on global equities, please see: Global Equity ESG, H1 2023 Report.

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