Capital Ideas^TM

Policy divergence took centre stage during the second quarter. The European Central Bank, alongside some other G10 central banks, dialled back on policy restrictiveness, while the US Federal Reserve and Bank of England left policy rates unchanged. The consequent implication of interest rate differentials on currency and relative global financing conditions are likely to be a recurrent topic in the coming months.

Several major central banks have made upward revisions to their inflation forecasts following stronger-than-expected data prints in the earlier part of the year. However, more recent inflation prints, particularly in the US, have signalled that inflationary pressures are again slowing, albeit at a gradual pace. While officials await further evidence showing progress on bringing inflation down to target levels, the likely direction of travel leans towards a shift to an easier policy environment globally over time which should be a tailwind for duration-related assets.

US Treasuries sold off moderately in the second quarter in response to the resilient economic backdrop and updated central bank forecasts. In the US and UK, expectations for rate cuts have been pushed back to the second half of 2024, with around 45 basis points (bps) of cuts priced in, while an additional 40 bps of cuts have been priced in for Europe this year. In contrast, the Bank of Japan is expected to continue to tighten following its policy shift away from negative interest rates. At the long end of bond yield curves, US term premiums have risen in response to ongoing concerns over budget deficits and Treasury supply, while higher longer term rates in Europe reflect the increasing uneasiness around the region's fiscal outlook given the challenging political backdrop. 

We continue to favour yield curve steepeners as global central banks start to ease monetary policy in a meaningful way and the pace of economic growth moderates. Alternatively, this strategy could also be beneficial in an environment in which the long-dated yields rise due to supply issues resulting from ongoing budget deficits. In addition, the curve steepener position may help mitigate against the risk of investing exclusively around the binary outcome of hard vs soft landing. Although there are downside risks if central banks begin raising rates, the bar for returning to a hiking bias remains high given the current restrictiveness of monetary policy. On a relative basis, we favour steepener positions in the US over those in Europe and the UK. In terms of duration positioning, our view is more balanced given market pricing leaves little margin for error.

Major yield curves remain inverted offering opportunity for steepening positions to add value across multiple scenarios 

Data as at 30 June 2024. Chart shows 2s10s curves for major markets. Source: Bloomberg