Interest landscape
The various levels of key interest rates - including the actual level, the expected level, the hoped-for level and the necessary level from different perspectives - have characterised the year 2024. Have tempted some investors to bet on the interest rate turnaround too early. Or to prepare for it too late. Tobias Geishauser, Co-Fund Manager of DJE - Zins Global, explains what the interest rate turnaround means for bond investors and where the opportunities and risks lie.
The current year has brought some surprises on the bond markets. While many market participants expected the central banks, in particular the European Central Bank (ECB) and the Federal Reserve (Fed), to cut interest rates more quickly for the first time, there was no monetary easing until the summer. It was not until June that the ECB lowered its key interest rate for the first time in eight years, which influenced bond markets and other asset classes. The Fed only recently followed the Europeans. But what does this mean for investors who have invested in fixed-interest securities or are interested in bond investments?
A look back at the first half of the bond year
In the first half of the year, the bond markets continued to react strongly to monetary policy signals, particularly from the US and Europe. Central banks largely stuck to their restrictive course, which put long-dated government bonds in particular under strong pressure. The bond market priced in potential interest rate cuts too euphorically, which was reflected in falling yields until the autumn. Many yield curves were inverted: The total returns of long-dated government bonds from developed economies such as the US, UK, Japan and Germany remained consistently negative until the end of June. The expectation of rising interest rates ultimately ensured that investors acted cautiously.
However, the performance of high-yield bonds was particularly remarkable. European and American high-yield bonds recorded solid returns, which can be attributed to the narrowing of credit risk premiums to investment-grade bonds with good credit rating structures, also known as credit spreads, and strong demand. Companies with such structures held up well through the high yield periods. As a result, European high-yield bonds achieved a return of around 3% by the end of June, while US high-yield bonds in US dollars even exceeded 5% (in euros). This shows that It is precisely in challenging times that the credit markets can surprise.
Why the interest rate environment for bonds remains attractive
One of the main reasons for the positive development in the high-yield segment is the strong demand from institutional investors such as insurance companies and pension funds. These investors are looking for stable returns in an environment that continues to be characterised by uncertainty. While credit spreads are historically in the bottom third, European investment-grade bonds have yields that are in the top third in a historical comparison of the last ten years. Even though yields have fallen in recent months, they remain attractive. Investors who invest in bonds now can secure predictable cash flows and income over the long term.
In addition, many companies have been able to take advantage of the favourable interest rates in recent years to refinance themselves in the long term. This applies in particular to quality companies that have adjusted their capital structure accordingly. The key figures of these companies, such as the ratio of debt service to free cash flows, remain solid, which emphasises their ability to deal with higher interest rates.
The wind is changing - what this means for investors
With the first interest rate cuts by the ECB and now also the Fed, the macroeconomic environment has changed noticeably. Many market participants are assuming that further interest rate cuts will only be made cautiously in the coming months. This expectation is making bonds increasingly attractive on both continents. However, investors should remain vigilant, as geopolitical risks and the uncertain inflation trend could continue to exert pressure on the markets.
In this interest rate cycle, the Fed reacted more cautiously than usual and left interest rates as high as they were for a long time. It was not until September that the Fed eased its monetary policy and lowered interest rates by 50 basis points, the same as in Europe. This meant that the prospect that the key interest rate might not be lowered until after the US elections in November did not materialise. The reason for this could be the structurally weaker US economy, which left less room for manoeuvre in the decision. In view of the ongoing challenges, it remains to be seen whether the Fed will move away from its rather cautious stance.
In an environment where further interest rate cuts are expected, but may only come gradually and hesitantly, investors should pay particular attention to their choice of bonds. Although fixed-interest securities such as government bonds and corporate bonds continue to offer stable and predictable long-term returns that can be secured now, the course of medium-term interest rates remains uncertain. Long-term bonds could be particularly vulnerable to price losses if, contrary to expectations, interest rates do rise. Investors should therefore pursue a careful strategy that balances maturity and coupon yields.
Do not underestimate risks: Maturity Wall
High-yield bonds currently offer interesting opportunities, but here too investors should be selective. Companies that are active on the US high-yield markets may face considerable refinancing requirements in the coming years. Experts estimate that around USD 2.5 trillion will need to be refinanced in both 2025 and 2026. This so-called ‘maturity wall’ could weigh on the market and create headwinds for credit spreads if the capital markets are unable to provide sufficient liquidity.
What could future interest rate cuts mean for investors?
Although interest rate cuts appear positive for the markets at first glance, there are also risks involved. Companies and governments could take on excessive debt in a phase of low interest rates. If interest rates rise again in the coming years, this could lead to considerable financial burdens. Companies that have to refinance themselves in the short term or are heavily dependent on the capital market are particularly vulnerable.
A further risk is that investors will move into speculative asset classes that would be less attractive under normal market conditions. This could lead to a bubble forming, particularly in the equity and property sectors. Banks could also come under pressure as their margins fall when interest rates are low, which could affect their profitability.
Conclusion: A careful strategy is crucial
The first half of 2024 has shown that interest rate trends remain difficult to predict. Investors should therefore pursue a flexible and active investment strategy that takes into account both bonds and alternative asset classes. In an environment in which interest rate cuts are expected but not guaranteed, careful and dynamic management of the capital commitment period is crucial - in asset management, this is referred to as ‘duration management’. Currency risks also play a role and should be taken into account if you want to remain invested in bonds for a long time. The markets remain volatile and only those who adapt quickly to changing conditions will be successful in the long term.
For investors looking for stable returns, bonds continue to offer attractive opportunities. However, risk management should not be overlooked. A balanced investment strategy that focuses on diversification and utilises the opportunities offered by interest rate cuts remains the key to a successful investment policy in the coming months.
Note: Marketing advertisement - All information published here is for your information only and does not constitute investment advice or any other recommendation. The statements contained in this document reflect the current assessment of DJE Kapital AG. These may change at any time without prior notice. All statements made have been made with due care in accordance with the state of knowledge at the time of preparation. However, no guarantee and no liability can be assumed for the correctness and completeness.