Bond Watch: markets cheer falling US inflation

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

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Inflation cools in the US

The most important piece of data for bond investors this week was the October inflation number in the US. Higher-than-expected inflation is bad for bonds, as it implies interest rates will be higher for longer, while a lower number than expected suggests that rates will fall sooner.

The data was good, with US inflation rising 7.7% over the past 12 months compared with expectations of 7.9%. The rate was 8.2% for September, and the lowest since January, suggesting that inflation is starting to be tamed in the US as supply chain issues resolve and pent-up demand from the pandemic wanes.

The bond and stock markets liked the number, with the S&P 500 index of America’s largest shares jumping 3.5% following the news, and the yield on the 10-year US Treasury bond falling from 4.1% to 3.9%. Yields fall when bond prices rise.  

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Seema Shah, chief global strategist at Principal Asset Management, says the news will be cheered by the US central bank.

Shah said: “The first downside surprise in inflation in several months will inevitably be received by an equity market ovation. Not only is headline Consumer Price Index (measure of inflation) back below its pre-Russia/Ukraine conflict level, but some details of the report suggest the long-awaited decline in inflation could now be under way.”

A ‘bond renaissance’, says Pictet

Bond markets are more attractive to investors now than they have been for years, and in some cases decades, Pictet’s chief investment officer for bonds Raymond Sagayam argued this week.

The Swiss asset manager said that the bond sell-off in 2022, which has increased yields on offer from bonds, means that investors should once again pay attention to the bond market.

Sagayam adds that even in the face of sticky inflation and further rises in yields, investors could still manage to generate positive returns.

One area he singled out was emerging market debt, due to falling inflation, weak currencies and economic strength.

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Sagayam said: “Emerging market debt already looks interesting from a tactical point of view. Indeed, emerging market economies are in much healthier positions than they were in previous cycles, and emerging market central banks have been further ahead of the inflationary curve, offering meaningfully higher real rates than their developed market counterparts. In addition, emerging market currencies are deeply undervalued, especially against the dollar.”

Nevertheless, he warned that bonds globally could be undone by stagflation (high inflation and low growth), and that it is too early to draw absolute conclusions that the war on inflation has been won.

Active or passive?

Data firm Morningstar looked at how active funds had performed against passive rivals over the past decade.

Its “Active/Passive Barometer” spanned nearly 30,000 active and passive Europe-domiciled funds.  

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The results were not good for active funds. In bonds, the average 10-year manager success rate against a passive rival was 21%, below the 24% for equity funds.

Among the brighter spots, the success rate for active funds in the euro corporate bond and euro high-yield bond categories stood at 43% and 40%, respectively.

By contrast, the success rate for active funds in the global emerging markets bond−local currency category was 9%, while that for US dollar government bonds was 8%.