Better short maturities for bonds to avoid price fluctuations
If the ECB and Federal Reserve did not cut rates, long-term yields would adjust upwards with a depressing effect on prices
Key points
Uncertainty also dominates the bond market and the risk of a rebalancing of bond prices cannot be ignored. Underlying the vulnerability of bonds is the gap in market expectations for interest rates and bond yields in the near future, particularly for US issues. Indeed, the market still expects cuts in the US, but it is not certain that growth and inflation will still require reductions in the cost of money. Should it not be necessary to cut rates, the yields of bonds traded on the market would adjust and rise, causing prices to fall (for fixed income prices and yields go in the opposite direction).
Long-term risk
The potential loss of value would mainly affect long-term bonds and, for this reason, which fluctuate more widely than short-dated bonds, because they bind the investor for longer. Analysts who are less optimistic about the bond market therefore recommend staying on short duration. Duration is similar to the duration of a bond, but indicates the time - expressed in years - it takes to get back the initial capital after taking into account coupons and any capital repayments. The difference increases depending on the frequency and size of coupons.
Shorter deadlines less vulnerable
Peter van der Welle, multi-asset strategist at Robeco, explains that in both the US and Europe, short maturities are preferable, although upside and downside risks to bonds seem to balance each other at the moment: 'On the one hand, there are upside risks to US 10-year Treasury yields with synchronised growth globally and investors would demand higher real yields, especially if inflation remains more persistent. A more Trump-compliant Federal Reserve Governor holding rates below neutral for longer than warranted by the strength of the US economy, investors would also realise new inflation risks in the medium term. On the other hand, there are pronounced recession tail risks, which would rally Treasuries. For this reason, we prefer to hold a neutral stance on US bonds'.
Europe, more stable scenario
In Europe, Van Der Welle also prefers an allocation to short bonds, but for different reasons. In the Old Continent, the risk on long-term bond prices depends on the massive fiscal plans of Germany and France, which would bring more growth, inflation and a less expansive monetary policy. "The ECB," points out George Bory, chief investment strategist of Allspring's fixed income team, "is far ahead of the Fed in terms of expansionary policy, because it has cut rates by 225 basis points from June 2024 to June 2025. At current levels, the ECB's benchmark rate is very close to neutral and in line with inflation and, therefore, should be slightly stimulative for the European economy without putting any particular pressure on inflation."
Jeff Mueller, Co-head of fixed income at Morgan Stanley Investment Management, confirms that the European Central Bank is not expected to cut interest rates further in this monetary policy cycle, unless the economy deteriorates unexpectedly. Growth is resilient, though not particularly robust, the economies of southern European countries are doing better than those of Germany and France, and core inflation is slowly falling towards the 2 per cent target. The yield premiums on riskier bonds are more compressed than in the past, as credit and systemic risks are judged low and banks have started to relax their lending parameters. This helps both governments and companies to finance themselves at more affordable levels and reduces the need for further stimulus from the ECB.
