Market report

Interest rate and inflation expectations, government debt and investing in bonds.

March 18, 2024
5 min.
Interest rate and inflation expectations, government debt and investing in bonds.

Chart of the week

Source: X, Jurrien Timmer, @TimmerFidelity, 15.03.2024

The chart shows the yield on the ten-year government bond in the US (black), the higher of the key interest rates (yellow), the expected interest rates based on the prices of futures contracts (orange) and the expectations of the interest rates of the voting members of the US Federal Reserve (purple dots).
Why this is important
How high interest rates are and how they develop is crucial for the development of the stock market. All market participants and the voting members of the US Federal Reserve agree that interest rates have peaked and will fall in the future. It is unlikely that interest rates on ten-year government bonds will rise above 5% again.

Where many disagree, however, is how long interest rates will remain at the current level. At the beginning of the year, seven interest rate cuts were expected, but now only one is expected by the end of the year.

Interest rate and inflation expectations
In recent weeks, many figures have been published that shed light on the further development of interest rates.

Source: X, Equity Clock, @EquityClock, 14.03.2024

Retail sales came as something of a negative surprise. These remained very strong. The chart above helps to assess this. Retail sales have a clear seasonal trend. They are low at the beginning of the year and at their highest around Christmas. In blue you can see the average of the last few years, in green the figures from last year and in red the figures for 2024. Retail sales are above the long-term trend, even above the figures from a year ago, and there are no signs of a slowdown.

Source: X, Equity Clock, @EquityClock, 14.03.2024

Industrial production (red) was received somewhat more positively. Although this is also still above the long-term trend (blue), it is significantly below last year's development. For the first time, a clear weakening of the economy can be seen here. This is currently being interpreted positively, as it averts the danger of rising interest rates and raises hopes of interest rate cuts.

Inflation is developing somewhat more stubbornly. Inflation was expected to reach 3.1% in February last week, but has now been reported at 3.2%. Although the economy is cooling somewhat, inflation is not falling any further. Is this a cause for concern?

Source: Stock3; Waren die US-Inflationsdaten gut oder schlecht?, 12.03.2024

In addition to commodity prices, wage growth is also decisive for the development of inflation. Wage growth is particularly worrying if it is higher than productivity growth. This is not currently the case. As the chart above shows, wage growth minus productivity (light blue) has good predictive power for inflation (dark blue). Based on this correlation, lower inflation is to be expected in the coming months. This could be disrupted almost exclusively by geopolitical uncertainties leading to a sharp rise in the price of oil.

Source: Stock3; Waren die US-Inflationsdaten gut oder schlecht?, 12.03.2024

This chart also shows that declining wage costs (gray) are to be expected. A good indicator of the expected wage costs is the number of voluntary redundancies (blue). The fewer people resign because they receive a better offer, the lower the wage growth will be.
Somewhat worrying, however, are the financial conditions for companies, which indicate how easily companies can finance themselves. Better conditions lead to an increase in the blue line.

Source: Stock3; Waren die US-Inflationsdaten gut oder schlecht?, 12.03.2024

Better financial conditions for companies are leading to increased investment and a rise in economic growth (gray), which could tempt the US Federal Reserve not to cut interest rates after all.
The positive and negative indicators are currently in balance. As a result, interest rates are not expected to be cut this week either.

Government debt and investing in bonds

Source: Pictet: Monatliches Konjunktur- und Finanzmarktbild März 2024

The chart shows the real interest rates (interest rates minus inflation) of government bonds in the respective countries. Investors in USD receive good interest rates in the USA and investors in EUR in Italy and France. Investors investing in Swiss francs, on the other hand, do not fare so well. Without taking currency risks, investing in bonds is not worthwhile.
Government debt is important for the further development of government bond prices.

Source: JPM, Guide to the Markets - Europe. Data as of 29 February 2024.

The chart shows the expected national debt in relation to gross national product (left chart). This is the same as if the annual earnings of a private individual were set in relation to the debt. With a value of 110, the USA (black line) therefore has more debt than it earns per year. It is also expected that the debt in the USA will continue to increase massively. Even more so with a future President Trump than with Biden due to the tax cuts. As interest rates have risen in the USA, the interest burden for taxpayers is also rising to new record levels. Sooner or later, investors will take note of this again and it should lead to a lower USD. However, as the USD is considered a safe haven in times of crisis, this has not been the case so far.
Things look more positive in Europe. Government debt in relation to gross national product is expected to fall. The money that countries have to spend on interest payments has risen only minimally. Nevertheless, the value must be monitored closely. If it rises, we will be faced with another euro crisis, as individual countries will then no longer be able to pay their interest.

Source: JPM, Guide to the Markets - Europe. Data as of 29 February 2024.

The chart shows which interest rates are currently available for which investments on the bond market. The scale marked in red (left) is primarily important here. The higher the risk, the higher the yield. Government bonds (blue, left) offer the lowest yields (1-4%), while bonds issued by high-risk companies and/or emerging markets (green, right) offer the highest yields (5-11%).
At first glance, the figures look very high and suggest a good investment opportunity, but the currency risks must not be ignored.

Currently, Swiss corporate bonds yield 1.3% (Nestle maturing in 2029) and US corporate bonds yield around 5%. So 3.7% more interest. So a great deal?
Not quite. In 2023, the USD has lost 9.5% in value against the CHF. Instead of a 1.5% gain, you would have made a 4.5% loss. Sometimes less is more.

That's why we don't take any currency risks for our clients with bonds. When we invest abroad, we only ever do so on a currency-hedged basis.
As there is still a risk of recession, we are currently focusing on government bonds. If there is a recession, the risk premiums for corporate bonds, which are currently at an all-time low, will increase massively and lead to losses. Here too, less is currently more.

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