GOVERNMENT BOND YIELDS CLIMB AS MARKETS TURN LESS OPTIMISTIC ON RATE CUTS

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Data Sourced from FE Analytics, and Bloomberg Finance LP

GOVERNMENT BOND YIELDS CLIMB AS MARKETS TURN LESS OPTIMISTIC ON RATE CUTS

This week a general sense of pessimism returned to bond markets as the prospect of central bank rate cuts has been pushed back, again. Leading the case for higher for longer rates is Neel Kashkari, president of the Minneapolis Federal Reserve bank, who warned that several months of sustained disinflation are needed before the US Fed is able to cut. The European Central Bank signalled that a June rate cut is very much on the cards. However, rising inflation has also returned to the Eurozone and this added to the gloomy outlook.

There were some bright spots for investors. The Japanese economy continues to normalise and steady inflation and rising retail sales are providing room for the Bank of Japan to raise rates. In the UK, activity appears to be picking up in the residential property market and shop price inflation has fallen back to levels last seen 2021 – well below the Bank of England’s 2% target. Consumer confidence also ticked up again. But, with no shocks in the UK election campaign so far, signs of improvement are likely to be too small to alter the polling in the general election.

RATES: BONDS FALL AS HOPES OF EARLY US RATE CUTS FADE

Government bonds came under more pressure this week as investors turned more negative and pushed back their expectations for interest rate cuts. There were further signs that inflation is proving difficult to get back to target as inflation in Australia and the Eurozone accelerated last month. Several members of the US Federal Reserve appeared more aggressive about the need to tackle inflation. Minneapolis Federal Reserve president Neel Kashkari raised the possibility of a further rate hike and said US interest rates could be held at their current level indefinitely if needed. Although, the European Central Bank signalled it is likely to cut interest rates next week, but this was not enough to prevent Eurozone government bond yields from rising as well.

As well as weighing on bonds, the changed outlook for interest rates was also felt in currency markets. The pound has risen significantly against both the euro and Japanese yen as markets expect the Bank of England to delay its first rate cut until later this year.

EQUITIES: SEVERAL OF THE BIGGEST EM ECONOMIES HEAD TO THE POLLS

This is a significant year politically for emerging markets. This week, India, the world’s largest democracy, and South Africa both held general elections. Mexico votes in its presidential election this weekend. This is addition to elections in Russia, Taiwan, South Korea and Indonesia earlier this year.

Most of these elections are expected to bring continuity. In India, Prime Minister Narendra Modi is widely expected to be re-elected. In Mexico, the leading contender is from the outgoing president’s Morena party. The South African election result is far less certain as younger voters lose faith in the government and this has opened to the way for challengers to the ANC after 20 years in power. Overall, the elections are expected to bring little change economically and few shocks for financial markets. With incumbent or centrist parties generally doing well, the policies which have supported growth in India, Mexico and Taiwan should continue.

OIL: TENSION IN THE MIDDLE EAST LEADS TO VOLATILITY IN OIL MARKETS

The price of oil has been pushed higher by rising tensions in the Middle East. Despite calls for a ceasefire from many of its allies, Israel extended its invasion of Gaza as its army advanced into the southern city of Rafah at the weekend. The incursion resulted in a number of civilian deaths and an Egyptian soldier was also killed in a confrontation with Israeli forces. Meanwhile, Houthi forces in Yemen staged another attack
on shipping in the Red Sea.

The oil price has risen from a recent low of around $80 a barrel for Brent Crude last week to almost $85 a barrel before falling back. In addition to the tension in the Middle East, OPEC countries are widely expected to keep restrictions on oil production in place at next week’s meeting. Meanwhile, the oil and gas sector has seen an increase in corporate activity as Chevron’s acquisition of Hess was approved by Hess shareholders and ConocoPhillips has agreed a deal to buy Marathon Oil for $22.5bn.

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