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Global Bond Market:
Inflation risks remain, and the Fed may cut interest rates precautionarily
When exactly will the Fed start cutting interest rates? This is the core concern of the market, but the answer to this question has not been answered definitively for a long time, and the market's expectations have been repeatedly adjusted.
The market previously expected the Fed to cut interest rates for the first time at the end of the first quarter of 2024, but as the U.S. economic data continued to remain strong, and the resilient reality of inflation data, the market had to adjust its expectations several times, as shown in the chart below, Wall Street institutions' expectations for the Fed in the first quarter have been generally adjusted to start cutting interest rates in June, taking Goldman Sachs' view as an example, its view at the end of January 2024 is that the Fed will cut interest rates for the first time in May, and the number of rate cuts throughout the year is 5 times (25BP each time, a total of 125BP), By March, the latest report had been adjusted to expect the Fed to cut interest rates for the first time in June, with three rate cuts for a total of 75bp throughout the year.
In our view, the bond market will also face volatility in the second quarter due to the adjustment of inflation expectations. There are concerns about both components of the inflation data. One is the rent price, due to the continued high mortgage interest rate, some residents temporarily give up buying a house and turn to rent, resulting in a continuous rise in rent prices, bringing pressure on inflation, one is the price of crude oil, the recent crude oil price in OPEC to maintain the scale of production cuts, Ukrainian drone attacks on Russian crude oil facilities, IEA raised global crude oil demand and other factors, has climbed to a high of more than $80 / barrel, And some institutions even expect crude oil to have the hope of challenging the $100 mark!
Therefore, inflationary pressures may allow the Fed to remain cautious in order to avoid the double peak of inflation caused by the premature easing of monetary policy in the 70s and 80s of the last century. Even so, it is still possible that the Fed will first implement a rate cut in June, even if it is a precautionary one, as there are also some concerns about the risk of a sudden recession in the US economy. Overall, we believe that there is upward pressure on bond yields, but not too much, and it is difficult for the 10-year US Treasury bond to break above the 4.5% level.
Figure 1 Wall Street institutions have adjusted their expectations, and Goldman Sachs will cut interest rates for the first time
数据来源：The Wall Street Journal，Goldman Sachs
Global Bond Market:
Short-term debt has higher certainty, and long-term debt has allocation value
For U.S. bonds, short-term (Q2) perspectives are undoubtedly more certain. As analyzed above, at a time when inflation is highly uncertain, the Fed may not easily make a decision to cut interest rates quickly, but will tend to lag behind the economic data to make decisions. Therefore, we believe that the yield inversion in the bond market will continue for some time (as shown in the chart below, DWS expects the current situation of yield curve inversion to end in one year), so short-term bonds are still a more certain investment target. Considering that there may be a certain probability of interest rate cuts in the second quarter only in June, it is a cost-effective option to continue to hold short-term bonds, at least for the time being.
But the opportunity for long-term debt is also objective. On the one hand, the current yield to maturity of long-term bonds is also at a high level, which has formed a good protection for the duration risk of long-term bonds, and on the other hand, although the timing and speed of the Fed's interest rate cut are not clear, the general direction of interest rate cuts is still very clear, and the probability of long-term bond yields continuing to rise sharply is not high, at most it is a stalemate. In addition, there are still institutions that are concerned about the risk of recession in the U.S. economy, for example, the BCA said that a U.S. recession may not need a special reason, just like water freezes below a certain temperature, and if the U.S. maintains the status quo of high interest rates for too long, it will cause damage to the economy, which will eventually turn into a recession at some point. Therefore, if this happens, long-term debt will have a risk-resilient effect.
In addition, if we look at the price-performance index of stocks and bonds (E/P-Bond Yield), the current price-performance ratio of bond assets is higher than that of the stock market, and investors may prefer bond assets rather than stock assets in asset allocation, thus bringing continuous capital inflow to bond assets.
Figure 2 DWS forecast of the U.S. Treasury yield curve: gradually moving from maturity inversion to normalization
Source: DWS
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