Daily Management Review

A Two-Month Surge Of Unprecedented Magnitude Recovers The Battered Bond Markets


A Two-Month Surge Of Unprecedented Magnitude Recovers The Battered Bond Markets
Expectations that central banks would soon be reducing interest rates have propelled a massive two-month rebound in bond prices, saving the fixed income markets from an almost unprecedented third consecutive year of losses.
The benchmark for borrowing prices worldwide, the U.S. 10-year Treasury yield, fell 50 basis points (bps) in December following a 53 bps decline in November. Its two-month decline is the largest since the global financial crisis of 2008, when the Federal Reserve started cutting rates.
Based on LSEG data dating back to 1997, the global broad bond market index of ICE BofA, which covers both corporate and government debt, has increased by about 7% over the past two months, making it the greatest eight-week period on record.
The greatest borrowing costs in almost a decade faced by governments, firms, and families in October have eased due to the rapid decline in yields, which are inversely correlated with prices.
For heavily indebted nations like Italy, where bond yields are about to see their largest monthly decline since 2013, it has also been a blessing.
In December, central bankers dramatically shifted their rhetoric on inflation, which encouraged investors to place bets on rate cuts. That came after a stunning data-driven November in which U.S. and European inflation dropped significantly quicker than anticipated.
"We were surprised by the strength of this rally," said Oliver Eichmann, head of European fixed income at asset manager DWS.
Formerly well-known monetary policy hawks Christopher Waller of the Fed and Isabel Schnabel of the European Central Bank moderated their rhetoric in December, acknowledging what Schnabel called a "remarkable" decline in inflation.
The Fed's announcement that rate rises were ending during its December meeting sent up new waves of market excitement. Notably, Fed Chair Jerome Powell refrained from opposing market wagers on significant rate reduction in the upcoming year. The Fed's "dot plot" called for three 25 basis point cuts in 2024, as opposed to the more than 150 basis points that the markets had priced in.
"That was a surprise," said Jamie Niven, bond portfolio manager at asset manager Candriam. "And it does leave you with the question, what are they seeing that maybe the market isn't?"
The bond market's riskier segments have gained the most, becoming more alluring as investors wager on rate decreases in the upcoming year.
The benchmark 10-year bond yield in Italy is expected to decline by more than 75 basis points in December, marking the largest monthly decline since the 2013 euro zone debt crisis.
In the meantime, the difference between the yields on trash bonds and benchmark risk-free rates in Europe and the US has shrunk to its lowest point since the second quarter of 2022.
After two negative years brought on by inflation and rate hikes, the market was spared the shame of a third year in the red—something not seen in at least 40 years—thanks to the two-month spike in bond prices.
October saw bond indices fall as U.S. inflation and growth continued to surprise analysts, supporting the case for higher rates to stay in place for an extended period of time.
Currently, an annual increase of about 5% is anticipated for the ICE BofA wide bond market index.
Not every investor believes their good fortune will continue.
"It's gone too far," said DWS's Eichmann. He expects more "push-back" from central bankers in the new year and fewer rate cuts than priced in by markets.