Core government bond markets are still consolidating, with the yields of the 10-year government bonds of Germany, the US and the UK all trading below the temporary peak of mid- November.
Incoming economic data are still beating market expectations, such as the current cycle high in US consumer confidence or the 11-month high of the eurozone business sentiment index. Yet there are two factors keeping bond yields capped for the time being.
First, the market still worries about the Italian referendum taking place this Sunday. Investors recall the Brexit vote in the UK on 23 June and the US presidential election of 8 November.
Both of these generated outcomes the market had not anticipated, and led to harsh market reaction. Therefore, there is demand for ‘safe haven’ assets ahead of the Italian vote.
The second element is the confidence that neither the European Central Bank (ECB) nor the Bank of Japan will deviate from their ultra-accommodative monetary stance.
If anything, most commentators even expect more stimulus rather than less from the ECB when it meets on 8 December.
In the shorter term, the consolidation could continue but we warn investors that market liquidity will dwindle further and price swings could widen.
Given the solid momentum of the US economy, in particular the reported rebound in corporate profitability, we still prefer credit risk over duration as we see a lower default rate in the US in 2017, translating into gains of USD high-yield bonds.
Markus Allenspach is head if Fixed Income Research at Julius Baer