Global Fixed Income Strategy – Monthly Update
Global macro strategy
Are developed markets overpricing rate hikes?
Key takeaways
• We believe developed markets (DM) are currently overpricing rate hikes, making the short end of DM yield curves look attractive.
• US inflation and policy outlook: Cooling inflation and moderating growth should allow the Fed to stay on hold, relying on hawkish communication rather than additional rate hikes.
• Portfolio implications: Markets appear overly priced for further Fed tightening, creating potential upside for front-end and intermediate-duration bonds if disinflation continues.
• Europe/UK inflation and policy outlook: Rising energy prices have revived the risk of ECB and BoE hikes, but improving underlying inflation trends suggest any additional tightening could ultimately prove temporary.
• Portfolio implications: Markets may be overestimating future ECB and BoE tightening, supporting opportunities in the front end of European bond curves while leaving long-end duration less attractive.
While bond markets continue to price additional central bank tightening in the US, Europe, and the UK, we believe rate hikes are overpriced. Underlying inflation trends suggest that policymakers may remain cautious. Below, we highlight where we believe market pricing has diverged from economic fundamentals, creating potential opportunities at the front end of rates curves.
US: Cooling inflation will likely keep the Fed on hold
In the US, we believe inflation peaked in the second quarter and should moderate over the coming months. Recent data are consistent with this view: price pressures across the broader goods sector remain contained, shelter inflation continues to slow on a year-on-year basis, and more timely measures of market rents point to further moderation ahead. The effects of earlier tariff and energy shocks should also fade, absent renewed geopolitical tensions that produce another sustained rise in commodity prices. Meanwhile, domestic demand is cooling modestly below its potential pace, and the labor market is settling into a stable, low-hire, low-fire equilibrium — firms are cautious about adding workers, but layoffs remain low. Together, these dynamics should limit the risk of a renewed inflationary impulse, while allowing the economy to avoid a sharp downturn.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Non-investment grade bonds, also called high yield bonds or junk bonds, pay higher yields but also carry more risk and a lower credit rating than an investment grade bond.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
