Annualised performance data in euros at 30th April 2023.
U.S. 2-year yields (black line on chart) peaked at just over 5% in March 2023 and have since declined by over 100 basis points to 3.9% at the time of writing. Given that U.S. monetary policy (red line on chart) tends to follow the 2-year yield with a lag, many Managers are growing increasingly confident that Jerome Powell will soon communicate to the market an end to his interest rate rising cycle. If Powell has managed to deliver a soft landing for the U.S. economy while increasing interest rates by 500 basis points and also taming inflation, it would be a very significant achievement. Interest rate decisions impact the economy and markets with a long and variable lag, so the jury is still out on whether he has delivered on his objectives. However, so far, the outlook remains promising.
U.S. Treasuries should also continue to benefit from the disinflationary trend in the United States. 10-year Treasuries yield 3.4%, while 2-year Treasuries yield 3.9%. The U.S. yield curve has inverted and the bond market is signalling that inflation is becoming less of a concern. If U.S. economic growth continues to moderate and Fed policy becomes less restrictive, U.S. government bonds should rally. The copper-to-gold ratio (red line on chart), the market’s best barometer of inflation expectations, is also confirming that the peak in inflation is behind us for now. Note in the chart below that the copper-to-gold ratio tends to lead U.S. 10-year bond yields and the current trend remains down, which suggests that rates of inflation should continue to decline during the second half of the year.
In Europe, many Managers continue to favour EU inflation-linked bonds over EU fixed interest rate bonds. Europe has more of a structural inflation problem due to an overreliance on imported oil and natural gas. Our preference is therefore to receive index-linked coupons on our EU bond investments, which reset every six or twelve months when coupons are paid.