Core sovereign bonds: update

Ten-year core sovereign bond yields have fallen steeply this summer on the back of continued disinflation, an unwinding of carry trades and downside surprises in the US labour market. This has sharpened markets’ focus on central banks’ plans for monetary easing, particularly the pace of cuts and the terminal rate.

The equity sell-off in early August showed that in a disinflationary environment core sovereign bonds have reassumed their protective role in portfolios. We also believe US Treasuries could act as a hedge against an unforeseen US recession or in case of financial market turmoil.

The balance of risks has shifted from inflationary pressures to the slowdown in manufacturing and the labour market. This means that central  banks could deliver more aggressive rate cuts than in our central scenario. For this reason, we have revised lower all our year-end forecasts for 10-year core government bond yields (except for bonds in Japan, where we expect more rate hikes).

Given the risk asymmetry that we see in central bank policy, we have moved from neutral to overweight in fixed income in general, including an overweight in sovereign bonds.