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Analysis-The world’s largest bond markets are back in fashion as recession fears intensify.

Government borrowing costs from Germany to France and Australia are down sharply this month, with 10-year bond yields down around 50 basis points each in July and poised for their steepest monthly decline for at least a decade.

US 10-year Treasury yields have slipped some 80 basis points from 11-year highs reached in June as decades-high inflation fueled expectations of aggressive Federal Reserve interest rate hikes.

Of course, persistent inflation means not everyone is buying bonds, and Friday’s data showing inflation in the eurozone hitting a new high sparked further bond selling.

But a change seems to be taking place as signs of slowing economic growth suggest that a peak in official interest rates is near. This means government bonds that investors shunned in the first half of 2022 are regaining their appeal.

German Bund yields poised for biggest monthly decline since 2011:

Bond funds saw inflows worth $3.6 billion in the week through Wednesday, the largest since March, according to BofA’s weekly flow analysis released on Friday.

Antoine Bouvet, senior rates strategist at ING, said he wouldn’t be surprised if the yield on the 10-year German Bund tested 0.5% in the coming months. It was 0.9% on Friday and had reached almost 2% in June.

“The tide has indeed turned, bonds are acting like recession hedges again,” Bouvet said.

Thursday’s data showed that the US economy contracted again in the second quarter. Eurozone data on Friday showed the bloc holding up better than expected, although powerhouse Germany is on the brink of contraction.

Trade activity in major economies weakens:

THE LONG TERM GAME

Investors are increasing their exposure to longer-term debt due to growth concerns.

Flavio Carpenzano, chief investment officer at Capital Group, which manages $2.6 trillion in assets, said he had started increasing duration, which represents sensitivity to movements in underlying interest rates.

“Recently, we have reduced the duration underweight (positions) because Europe might go into recession, and in that case we want to have core assets like German Bunds,” he said. .

“With this in mind, we have gradually started to increase the duration through German bonds in the 10-year part of the curve in order to protect the portfolio on the downside.”

Total returns, including capital gains and coupon payments, on Austrian 100-year bonds are up 33% in July, according to Refinitiv data. But as with most very long-term debt, an investor who bought at the start of 2022 would be in sharp decline since the start of the year.

The European Central Bank raised rates by 50 basis points last week and markets fully priced in another big move in September. They now assign a roughly 42% chance of another half-point upside.

Markets are pricing in a peak US interest rate of 3.2% by the end of the year and rate cuts of 50 basis points in 2023. Just before the Federal Reserve hikes rates to At 75 basis points in mid-June, it had seen US rates peak over 4% in 2023 and only one rate cut of a quarter point by the end of next year.

Earlier this week, the Fed raised rates another 0.75%.

Seema Shah, chief strategist at Principal Global Investors, said the company had increased its exposure to US Treasury bills and investment-grade corporate debt given recession risks.

“We expect a recession in 2023 and believe the Fed will start cutting rates towards the end of next year and so it is difficult to see a sustained rise in US bond yields,” she said.

The reversal in US yields is a harbinger of recession:

Investors said the outlook for Europe’s peripheral bond markets, such as Italy, was more complicated given concerns about growth and political instability.

Capital Group’s Mr Carpenzano said he remained underweight Italian bonds.

Others said the downward move in bond yields was not a one-way bet as the fight against inflation was far from won – price growth in the euro zone hit a new record high. 8.9% in July.

“I feel like the rate hike is overdone,” said Tim Graf, head of EMEA macro strategy at State Bourse.

“German 10-year bond yields of 0.9%, given inflation, are not something I would want to own,” he added, noting that Bund yields could go back towards 1.25. -1.5% by the end of the year.

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