Schroder Investment: The interest rate reduction cycle in Europe and the United States has arrived, pay attention to the central bank's monetary policy differentiation

According to the Wise Finance APP, Schroders' Hong Kong Fixed Income Investment Director Wu Meiyan stated in a post that as expected, the Federal Reserve announced a 50 basis point cut in the federal funds rate in September, which is more accommodative than the market's expected 25 basis points. This move indicates that the Fed's focus has shifted from inflation to the current state of the job market, and it is more inclined to release dovish signals for negative situations rather than adopting a hawkish approach for positive situations. Based on the current interest rate changes, it is expected that by the end of 2025, the U.S. federal funds rate will decrease from the current level to the neutral rate level.

Although the rate cut in the U.S. is in line with expectations, observing the market performance, the yield on the U.S. 10-year Treasury bond has risen instead of falling since the rate cut announcement, indicating that while inflation pressures in the U.S. are gradually decreasing in an orderly manner, the job market data remains robust. In addition, fund movements can also affect bond market performance. For example, China introduced larger-than-expected economic stimulus measures before its Golden Week holiday, leading to a significant shift of funds towards the stock market. Fund flows and policy changes may both impact bond price trends, causing the yield on the U.S. 10-year Treasury bond to reach 4% again after the end of the long holiday in China.

Apart from macro factors, geopolitical changes also pose challenges for investors. The uncertainty brought by the new Japanese Prime Minister affects the performance of the Japanese stock market. Geopolitical conflicts in the Middle East have led to an increase in oil prices. The upcoming U.S. congressional and presidential elections in November will also test the market with increased volatility.

In theory, central bank rate cuts should lead to lower interest rates and higher bond prices, making it a good time to invest in the bond market. However, in the face of many uncertainties, investors should be more flexible and cautious in positioning themselves in the bond market to truly take advantage of the rate cut.

Firstly, despite entering a rate-cutting cycle, the increased market volatility means that investors should not rashly extend the duration as the sole solution to interest rate risk. Instead, they should choose a flexible duration allocation strategy to address interest rate risk. For example, the long-standing inverted yield curve is expected to gradually normalize after entering a rate-cutting cycle, meaning that short-term bond yields will be lower than long-term bond yields.

In this context, unless the risk of an economic recession significantly lowers the trend of long-term bond yields, the downward movement of bond yields in the 1 to 5-year range will be more attractive for investment than longer-term bonds, given the current macroeconomic environment's judgment towards an "economic soft landing" development.

Secondly, apart from Japan, major central banks such as the U.S., UK, and Europe have started cutting rates, with China intensifying its rate and reserve requirement cuts to boost the economy. Among developed countries, the risk of economic recession in Europe is significantly higher than in the U.S. and UK, so in terms of interest rates investment, Europe's duration is more favorable than the U.S. and UK.

In terms of bond types, Schroders continues to favor investment-grade corporate bonds with high credit quality because these companies are usually better equipped to deal with downturns in the business cycle and benefit from the cost reduction advantages brought by the decline in interest rates. In terms of regions, European valuations are more attractive than the U.S., with higher potential for bond price increases. As for high-yield bonds, attention should be paid to deploying them selectively in companies with high financial stability and better profit capabilities.

In the Asian bond market, the performance of Asian bonds has been remarkable this year due to relatively higher yields and significantly reduced default risks. Schroders relatively prefers sectors such as finance and banking in Asia, which benefit from the high-interest environment and enhance profitability, and actively explores high credit quality corporate bonds from Australia and Japan Chinese USD bonds will require further fiscal stimulus to support a broader economy, especially the real estate market. In the long run, as long as household and corporate confidence can be restored, real demand can be boosted, strengthening market investment sentiment.

The global bond market has seen a significant price rebound since the second half of the year due to continued reactions to interest rate cut expectations. Even as we truly enter an interest rate cut cycle, Schroders remains optimistic about the bond outlook for reasons including: macro data increasing the possibility of an economic "hard landing," central banks around the world responding differently to data releases, leading the bank to focus on increasing bond investment durations during market volatility to gain more returns. Policy differentiation may also bring about different bond investment opportunities.

Schroders expects a more accommodative interest rate environment by the end of 2024, benefiting global bond market investors. However, the U.S. presidential election remains a market focus, which could exacerbate market volatility. Investors should adopt a globally diversified approach, enhance credit quality, maintain flexibility in the face of interest rate risks, and prioritize prudence to participate in global bond market investment opportunities