In Europe and the US, inflation rates are coming down, closer to central bank targets. Growth is showing signs of weakness in the US. In the eurozone, while the services sector is accelerating, the manufacturing sector has been contracting for almost two years.
Our interest rate scenario predicts that the ECB will cut rates three times this year. The first rate cut occurred at the beginning of June. We think the Fed will follow suit by cutting its key benchmark rate later in the year.
There is a strong correlation between policy rates and bond yields, and between bond yields and bond returns. When central banks cut benchmark rates, bond yields fall, and bonds tend to perform well.
Given the upcoming drop in deposit rates and the risk of reinvesting cash in this context, it is therefore necessary to move from savings to investment and to consider products with longer maturities. Investors will thus be able to lock in the current high rates for a few years in order to take advantage of high coupons and potentially benefit from capital appreciation.
Our recommendations
A theme that mainly focuses on bonds
We are Positive on US Treasuries, US inflation-linked bonds, US Agency Mortgage-Backed Securities and UK gilts.
European and US investment grade corporate bonds.
We are also Positive on emerging market bonds in hard and local currency. For some of these markets, valuations are sometimes stretched, but fundamentals are strong/improving. Carry is attractive.
Diversified infrastructure funds with growing yields, energy infrastructure funds and ETFs.
High-income solutions indexed to inflation.
Key risks
Inflation erodes the purchasing power of the fixed interest payments that bonds offer, which can make them less attractive relative to other assets. Persistent inflation leading to further rate hikes by central banks (very low risk in the eurozone and low risk in the US).
A deluge of bond issuance and weak demand would push bond prices lower.
