The exchange rate will be the key criterion. Since the US Federal Reserve reduced key interest rates to zero, the euro and the US dollar have moved significantly closer together in terms of interest rate differential. Additionally, the European Union, with its agreement on a quasi-fiscal union, has gained in popularity among investors. Even though the dollar has regained strength, it is likely to trend somewhat weaker against the euro over the next twelve months.
The yield on 10-year US government bonds initially fell to 0.39 percent in recent months before rising again to almost 0.8 percent. “We believe that a rise in yields to one percent will be possible in the coming months”, Gerlinger pointed out. Irrespective of the outcome of the US presidential elections, it is expected that both candidates will accept significantly higher government debt to implement their programmes and plans.
The resulting predicted increase in yields at the long end will lead to an overall steepening of the yield curve. At the short end, interest rates will remain stable at a very low level. “Market participants do not expect the Federal Reserve to take an interest rate move prior to 2023, and some even only towards 2025”, explained Gerlinger.
Corporate bonds are also interesting: Corporate debt remains high. “Spreads on high-yield bonds have narrowed again since the beginning of September, but remain high at just under 500 basis points and thus attractive in absolute terms”, said Gerlinger. To date, there have been no notable defaults, but the segment carries higher risks in recession periods. The high-yield segment is boosted and supported by the US Federal Reserve’s announcement that it also intends to buy HY bonds as part of its bond purchase programme (Fed put). “We expect the segment to continue to be characterised by higher volatility. The wheat is separating from the chaff in bond picking”, Gerlinger pointed out.
Bunds also developed similarly to the US bond market: “As in the US, we expect additional slight steepening of the yield curve for Bunds at the long end”, said Gerlinger. In absolute terms, however, the yield level remains unattractive. “For this reason, government bonds are now only suitable as an insurance instrument against periods of stress”, Gerlinger concluded. “The fiscal union in the European Union that was resolved through the back-door favours government bonds from the peripheral states.”
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