US government bonds had their best return since the global financial crisis as markets became increasingly confident that interest rates have hit their peak.
Treasuries returned 3.6 per cent in US dollars in the month of November, their best return since 2008.
The US Aggregate Index, which also includes corporate debt, had its best return since the 1980s.
“Markets are increasingly sure that central banks have finished raising interest rates and will be able to cut them potentially as early as May 2024,” said Richard Carter, head of fixed income at Quilter Cheviot.
“There are increasing signs that inflation pressures are easing while the hawkish rhetoric from the Fed and other central bankers has begun to soften.”
The US 10-year treasury now yields about 4.3 per cent, down from 4.93 per cent at the start of November.
UK government bonds have followed suit, and the 10-year gilt now pays 4.17 per cent, down from 4.51 per cent a month ago.
This was partly driven by US inflation data, which came in at 3.2 per cent last month, down from 3.7 per cent the previous month and showing that prices were easing more than expected.
The employment market was also cooling, and oil prices have pulled back sharply.
“The change in yields is a clear sign that investors are increasingly dismissing the Fed’s narrative that interest rates may need to remain ‘higher for longer’ and are, instead, now anticipating rate cuts in early 2024,” said Jason Hollands, managing director at Evelyn Partners.
While Jerome Powell, chair of the Federal Reserve, tried to tame markets by saying that the Fed was prepared to tighten policy if it became appropriate to do so, the markets seem to think it unlikely that rates will push higher.
Rates steadying or falling is good news for bond investors, as yields should mirror this downward direction.
As bond yields and bond prices have an inverse relationship, as yields fall, bond prices should head skyward.
With inflation cooling more quickly than expected, central banks are more likely to introduce rate cuts sooner than planned.
Pricing it in
At the moment, markets are pricing in that rates will begin to fall in the US and Eurozone in the spring, and are likely to be a full 1.25 percentage points lower by the end of the year.
In the UK, rate cuts are expected to start in the early summer and fall from 5.25 per cent to 4.5 per cent.
“Recent inflation news has undoubtedly been considerably better than expected, and rate cuts in the second half of next year are now looking very likely,” said Rupert Thompson, the chief economist at Kingswood.
“We believe that bonds and equities will outperform cash from here over the next year or two."
Thompson added: "The rally has highlighted how attempting to fine tune a move out of cash and back into other assets is a dangerous game, given the risk that markets jump the gun and much of the gains occur sooner rather than later.”
