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Bond Bears Beware

  • Global sovereign bonds caught a bid during the back half of May after a sentiment washout and classic contrarian bottoming signal.

  • Hot Eurozone inflation and buoying policies in China are not enough to offset apparent major global growth risks.

  • All eyes are back on the Fed with earnings season behind us and quantitative tightening commencing this month


More troubling global economic data hit the tape earlier this week. China’s manufacturing sector continued to run in contraction territory, with its purchasing managers’ index inching up to 49.6, still below the key 50 threshold. Then in Europe, inflation notched an all-time high at 8.1% year-on-year. Eurozone CPI verified much hotter than analysts were expecting. Meanwhile, in the US, the Economic Surprise Index has deteriorated – both Citigroup’s and Bloomberg’s indexes are at year-to-date lows.


Weighing the Risks


The world continues to battle near-term inflationary pressures and a growing global growth scare. Upshots might be optimism regarding China’s Covid lockdowns easing and steps that its government has taken to boost growth (and its stock market). Still, risks are to the bearish side. We see that in what’s happening with bond yields around the world. Once viewed as a risky asset class due to surging yields, fixed-income buyers have stepped up as growth expectations decline.


Taking Note


The US 10yr yield peaked on May 9 at 3.17%, about on par with its 2018 high during the previous tightening cycle. Second-quarter GDP estimates then retreated as corporate earnings and broad economic gauges revealed somewhat tepid growth. Sure enough, full-year 2022 and 2023 growth cuts came about as did a lowering of S&P 500 price targets for year-end. The 10yr note drifted down toward 2.7% last week as the market expected a less aggressive Fed tightening process. This week, yields ticked back up to near 2.9%, still well below the May peak.


Featured Chart: US 10yr Treasury Note Yield Drifts Lower as Consensus Bulls (inverted) Recovers

chart of bond market sentiment and bond yields

It’s not just a stateside story. Even with an uptick in sovereign bond rates on the heels of that hot Euro-area CPI data on Monday, we notice that global bond breadth has retreated from its high a few weeks ago. At the very least, this is a pause in the trend. At worst, it indicates recession risks ahead.


The Narrative Transition


Our Global Cross Asset Market Monitor, sent right before the trading week gets started, digs into the case for a bottom in bond prices. Our charts and analysis reveal that sentiment has greatly improved across global fixed-income markets – for both developed and emerging sovereigns. US inflation appears to be indeed on the decline, so the narrative shifts to downside growth risks come later this year and in 2023.


Too Soon


We are still very early in the tightening cycle (at least for the US). The Fed will hike its policy rate by 50 basis points at both the June and July meetings (in all likelihood) and quantitative tightening begins this month with the Fed selling $47.5 billion of assets in each of the next three months.


Bottom Line: We reiterate our bullish stance on US Treasuries and EM sovereigns. Risks are to the upside for fixed income (downside to yields) given a weakening global growth landscape.


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