Markets adjust to higher rates

Policymakers appear to be becoming less patient with persistent inflation, more confident in the resilience of economic growth and increasingly recognising that monetary policy may be less restrictive than previously thought.

This raises the possibility of a broader and more synchronised global policy adjustment. Financial markets are increasingly acting on this view. Investors are scaling back expectations of interest-rate cuts during 2027. As a result, yields on shorter-term bonds, particularly those with maturities of two to three years, have moved higher. Longer-term yields have been relatively stable.

One factor affecting long-term yields is the price of oil. Whenever oil prices rise above USD 100 per barrel, investors typically demand more compensation for holding long-dated bonds. Interestingly, when oil prices subsequently fall below USD 100, long-term yields do not decline to the same extent. This suggests investors are concerned about more than just energy prices.

Elections are putting pressure on both current and future governments to increase spending, resulting in larger fiscal deficits. These deficits need to be financed through additional debt issuance. Rising debt levels can lead to higher borrowing costs. To limit those costs, governments are increasingly issuing short-term debt. While this may reduce borrowing costs in the near term, it also makes governments more vulnerable to future central-bank decisions because short-term debt needs to be refinanced more frequently.

For investors, higher yields are becoming increasingly attractive because they offer better compensation for risk than they have for many years. The question is how far central banks are willing to go in their fight against inflation.

ABN AMRO's economists expect only limited further action from central banks and therefore forecast government bond yields to remain broadly around current levels. Financial markets, however, may still price in additional rate hikes, which could push yields higher across the yield curve. Our view is that bond yields are continuing to normalise and are becoming increasingly attractive for both shorter- and longer-term bonds.

Investors looking to enter the bond market may consider gradually locking in today's yields. We continue to prefer corporate bonds over government bonds. While we see value emerging in longer-term bonds, we are waiting for more attractive entry levels. For now, we favour maturities of up to 4.5 years.

Investors who already hold bonds may benefit from remaining patient. Further adjustments in bond yields could create better opportunities to increase exposure more aggressively at attractive levels.