Persistent inflation: what bond investors should consider now

The decline in the inflation rate is rather sluggish both in the USA and in Europe. Accordingly, monetary easing is also proceeding slowly. The situation in the bond market remains ambiguous. Nevertheless, some segments are likely to perform better than others. “We still see potential in high-yield bonds, and the short end of the yield curve remains attractive for the time being,” says Carsten Gerlinger, Managing Director and Head of Asset Management at Moventum AM.

Recently, the decline in the inflation rate has stalled. In the Eurozone, the rate increased from 2.4 to 2.6 percent in May. In the USA, there was a slight decline, but at 3.3 percent, prices are still rising too quickly. “Achieving the central banks’ inflation targets seems unrealistic at this point,” says Gerlinger. Wage growth and rising energy prices are likely to slow disinflation. This also raises questions about the pace of interest rate cuts.

Uncertainty about the future monetary policy of the US Fed means little enthusiasm at the long end. In the USA, only a maximum of two rate cuts are expected this year, although the surprisingly strong growth of the US economy so far this year requires no action from the US central bank. Some pressure on US long-term bonds could arise from the high supply of new issues. “Overall, in the context of a very inverted yield curve, the short end with a yield of 4.7 percent is interesting,” explains Gerlinger. He expects a flattening of the curve, with the long end hovering around 4.5 percent. The yield level of high-yield US corporate bonds of around 7.7 percent is attractive for many investors.

For the Eurozone, Gerlinger sees the possibility of further ECB rate hikes this year, but we must wait for the next inflation data. The ten-year German government bond currently yields 2.6 percent. “At this level, however, it is unattractive; its fair value should be over three percent,” says Gerlinger. In European corporate bonds, spreads have recently narrowed further due to the good fundamental situation of companies. Here, high-yield bonds are more interesting than investment-grade papers, as their yields provide a cushion in case of spread widening and or interest rate increases.

About Lisa Baker, Editor 2419 Articles
Lisa Baker is the Editor of Always Finance, and writes about Business, Finance Technology and Healthcare. Lisa is also the owner of Need to See IT Publishing.