Fra BNP Paribas
KEY MESSAGES
We believe the recent global bond rally was driven more by markets adjusting to renewed central bank balance sheet expansion and increasing likelihood of a Fed rate cut, than by recession fears.
The Fed could reverse part of its recent hiking cycle to head off recession, as it has successfully done in the past, for example in 1995. Chair Powell’s references to international “cross-currents” and downside data surprises make this no less likely.
Seen from this perspective, the pricing of the US curve, with negative carry to 10-years, makes sense. But where there is less scope for the central bank to cut rates (in the euro area, UK and Japan), it makes sense for carry to remain positive, limiting the scope for further yield falls..
What is behind the impressive bond market rally? And how should investors position now that valuations are even more stretched than before? Explaining the latest leg of the bond rally Four explanations present themselves:
1) Recession is coming; and the curve is anticipating this, as it usually does;
2) Financial markets’ recent risk-on move is fading, resulting in a bid for low-risk assets;
3) The Fed’s planned end of its balance sheet reduction, and the ECB’s planned new LTRO,
mean global excess liquidity will remain in the system for longer, driving demand for bonds;
4) The market now expects the Fed to cut rates. Judging by the timing of the rally, we tend to put most of the blame on (3) and (4), although no doubt weak data, especially in Europe, and stock
