The big bond debate: Bull or bear market in 2024?

Set against a backdrop of sustained global geopolitical and economic disruption , the world’s bond markets are moving through a period of great uncertainty. In the short term, there are questions as to whether yields have peaked as central banks pull the levers of interest rates to temper inflation without depressing economic growth. In the longer term, the rise of the Global South through new trade routes and multilateral economic agreements is shifting economic power away from the developed economies. The recently announced India-Middle East-Corridor reflects the scale of ambition and optimism across the developing markets – many of which are experiencing rapid economic growth thanks to their newly liberalised capital markets, national diversification strategies and large inflows of capital. The new corridor, revealed at the G20 summit in India this year, would create two new trade routes linking India to the fast-growing GCC and then on to Europe. Once it makes progress, its physical infrastructure, data networks, ports and gas pipelines will deepen economic and political ties between East and West, with the high-growth GCC countries acting as a de facto gateway for the economic interests of 1.4 billion people in the Global South. Capital raising for such development will be critical and we may well see nations tapping bond markets to facilitate this corridor. Moreover, the Middle East’s economic power base is to be further bolstered by Saudi Arabia and the UAE joining the Brics group in January. The challenge for investors is to make sense of these rapidly changing global dynamics during a period of historic debt, sluggish growth and political uncertainties in the developed economies. For the bond markets, these confusing signs are giving rise to disparate views on performance, creating a lack of consensus between bulls and bears. Bond bulls argue that today’s yield of around 5 per cent on the 10-year bond incorporates an extended pause by the US Federal Reserve at current policy rates, with a sizeable real (net-of-inflation) yield of close to 2.5 per cent. This would bring yields on 10-year bonds close to pre-2008 highs. However, bond bears argue that for yields to return to a normalised curve with long maturity yields above short maturity yields, the 10-year yield must rise above an extended Fed policy rate of 5.5 per cent, with a still-robust US economy. Such a move would be in sharp contrast to what we typically see in a late cycle when the yield curve normalises in response to a sharp fall in short-maturity yields precipitated by a downturn that prompts the Fed to cut rates. Whether US bond yields have peaked amid a still-robust US economy remains a key debate in markets. US growth accelerated in the third quarter of 2023 to a 4.9 per cent annualised rate on the back of strong summertime consumption. However, growth will likely slow significantly in the coming quarters amid tightening financial conditions from the lagged impact of 525 basis points of rate increases since March 2022 and the fading impact of pandemic stimulus measures. Furthermore, an elevated risk of recession in the eurozone and tight financial conditions across the EU and UK suggest that the European Central Bank and the Bank of England are unlikely to increase rates further as they nurture growth. Within the EU, major economies such as Germany have suffered significant contraction, particularly in manufacturing – Germany is particularly exposed to China, whose slowing growth dampens exports. All of these factors combined mean we continue to see an attractive risk/reward in high-quality government bonds – and we retain an overweight stance to developed market investment grade government bonds within our diversified allocation. Historical performance shows that bond yields tend to peak not far from the peak in the Fed policy rate, which we believe has been reached. Today’s yields, therefore, offer an opportunity to lock in the highest real yield since 2008. Furthermore, they offer a significant buffer against a further temporary fall in price. There is, of course, the possibility that yields could rise again in the short term if curve normalisation occurs through unchanged short-maturity yields and rising long-maturity yields with the Fed holding rates. However, a further significant rise appears unlikely, given cooling inflation and rising signs that borrowing costs are biting into household budgets. As inflation cools, strong earnings expansion in key growth sectors, such as technology in the US, are also supporting growth in the equity market. Corporate margins have remained strong in the US this year, alongside strong fundamentals and economic growth. Further afield in Japan, we see multiple positive factors, including a rise in share buybacks, net corporate cash positions, improvements in corporate governance and relative insulation to geopolitical events compared to its global peers. However, a potential tightening of the Bank of Japan’s monetary policy could dampen corporate earnings. Subsequently, global equities remain a core allocation in the Standard Chartered foundation portfolio – with the caveat that any escalation of the Middle East conflict risks lifting oil prices and reigniting inflation. Outside of Japan, we maintain a core balanced allocation for Asia, although Chinese markets continue to be weighed down by the country's weak property sector outlook despite stronger than anticipated consumption and industrial output. Despite a more settled outlook on rates and resilience in equities, the continued geopolitical uncertainties have led to many investors turning to precious metals. Gold prices have risen as high as $1,981 per ounce, despite surging real yields and the strength of the US dollar. These two latter dynamics are likely to sustain prices of around $1,980 per ounce over the coming quarter. Gold prices will also be buoyed by the holiday season, and in the long run, central bank demand and economic concerns are likely to remain key drivers supporting gold prices. As an effective short-term hedge, gold remains a core allocation within our portfolio, with a 12-month forecast of $2,010 per ounce. In contrast, heightened political tensions in the Middle East have created a much greater sense of uncertainty when forecasting the price of crude. Prices collapsed in October before then trimming some losses amid the conflict. The near-term is likely to remain elevated at around $90 per barrel because of the high level of uncertainty. However, beyond that and within the context of a probable overall slowdown in the global economy and an associated fall in consumption, we remain bearish on crude. Our 12-month WTI oil forecast is $75. Across our foundation allocations, we continue to side with the bulls and maintain an overweight stance to develop market investment-grade bonds within our diversified allocation. The unlikely event of further rate rises means that the yield curve is likely to normalise. However, despite the prospect of a year-end rally for equities, we expect a rangebound outcome as capped bond yields and positive earnings spar with an anticipated slowdown in US growth and overall global business activity. The backdrop is uncertain, but as we head to peak rates amid falling inflation, subdued consumption and weakening global growth, the big bond debate is likely to be won by the bulls. Manpreet Gill is the chief investment officer AMEE at Standard Chartered

The big bond debate: Bull or bear market in 2024?

The challenge for investors is to navigate rapidly changing global dynamics during a period of historic debt, sluggish growth and political uncertainties