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The third quarter was painful for global rates markets, with global government bonds returning around -4.2%1. Curves steepened as the ‘higher for longer’ narrative began to take hold and US and European longer dated yields moved higher. While the UK curve also steepened, this was driven more by falling front-end yields as expectations of further rate rises faded. Market expectations are for the current level of rates to be maintained into 2024 with a pivot to looser monetary policy pushed into the second half of the year.
Curve inversion reduced in Q3, led mainly by more elevated longer yields
Data as at 30 September 2023. Chart shows 2s10s curves for major markets. Source: Bloomberg
The divergence in global growth and inflationary conditions has become more pronounced. While we believe developed market central banks to be at, or very close to, the end of their hiking cycles, the US economy’s resilience stands out. In contrast, a weaker growth outlook, compounded by increased interest-rate sensitivity and greater exposure to the slowdown in China, means the transition to a less restrictive policy environment is likely to come sooner in Europe.
We see this as an attractive entry point for global rates exposure, given the uncertainty around the global macroeconomic outlook alongside higher yield levels. Should inflation continue to trend down, the need to maintain elevated rates will decline and it is likely that central banks will ease to avoid passively tightening real rates.
In our view, Europe and the UK represent the most attractive relative value, with curve steepener positions potentially benefitting as front-end yields adjust and term premium potentially increases. In contrast, we are underweight Japan rates as an exit or relaxation of yield curve control may be painful for Japanese duration. We find it challenging to reach a consensus view on currencies. Real rate differentials and a potential flight to safety are positive for the US dollar. However, this is offset by current high valuations and a potential Federal Reserve dovish pivot which could soften relative carry and undermine dollar strength.
US dollar richness returned in Q3 as it regained strength versus most major currencies
Data as at 30 September 2023. Chart shows foreign exchange returns for major currencies vs USD, and DXY. DXY (=US Dollar Index), GBP (=British pound sterling), CHF (=Swiss Franc), JPY (=Japanese yen), CAD (=Canadian dollar), EUR (=Euro), CNY (=Chinese yuan). Bps: basis points. Source: Bloomberg
1. As at 29 September 2023. Index: Bloomberg Global Aggregate Treasuries Total Return Index Value Unhedged USD. Source: Bloomberg
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