Global bond rally continues as markets eye rate cuts

Bonds around the world are extending gains on expectations that a wave of easier monetary policy will break out next year as inflation fears evaporate.

An index of sovereign debt that excludes Treasuries surged to the highest since April 2022, as rates traders switched to betting the European Central Bank will cut interest rates even before the Federal Reserve does. US government notes are also set for their first annual gain in three years, as bond investors position for an end to the economic resilience that made 2023 so challenging.

“Inflation fears are melting,” said Prashant Newnaha, a rates strategist at TD Securities Inc. in Singapore. “Central banks believe they have clearly done enough and may need to cut, otherwise real rates may be too high and restrictive.”

Fresh dovish comments from ECB officials mean investors now see Europe leading the way with a rate cut as early as March 7, with strong odds the Fed will follow suit just two weeks later. Even New Zealand, whose central bank said just one week ago it might have to hike rates next year, is now seen by markets as likely to cut in May.

What’s been a wild year for bonds looks to be ending with a sizzling rally as central banks move away from the hawkish stances that confounded expectations at the start of 2023 for a smooth return to gains for the asset class. 

A Bloomberg index of non-US government bonds is now up 6% since Dec. 30, on a hedged basis, after struggling to make headway for much of the year. Treasuries have rebounded to a 1.8% return this year, after being down as much as 3.3% for 2023 in mid-October.

The sea change in rate bets over the past week came as former hawks on both sides of the Atlantic stood down on the need to consider further tightening. 

Fed Governor Christopher Waller even acknowledged Nov. 28 that the Fed would consider trimming rates if inflation continues to fall. Isabel Schnabel, a renowned ECB hawk, didn’t go that far. She did however said on Tuesday that inflation is showing a “remarkable” slowdown and that another hike in borrowing costs is “rather unlikely.” 

While Schnabel stopped short of ruling out a cut within six months, Bank of France Governor Francois Villeroy de Galhau had said Friday the ECB will examine the question at some point during 2024.