Opportunities in fixed income?
US Treasury and Bund yields rose further this week, with ten-year yields now trading around the highs hit in May (4.67% for Treasuries and 3.19% for Bunds). The reason is the renewed escalation between the US and Iran, which is driving oil prices up again. Brent crude oil is rapidly approaching USD 100 per barrel from as low as USD 70 early this month.
For bond investors, these yield levels could be attractive, but only if the US and Iran manage to de-escalate and reopen the Strait of Hormuz again. We see this as the most probable scenario, as we have seen before that the economic consequences of the Strait of Hormuz being closed are too high for either the US or Iran to tolerate. In this scenario, there may be plenty of room for yields to fall and for expected hikes from the European Central Bank and the Federal Reserve to be priced-out. (When bond yields fall, bond prices rise).
Until there are signs of stabilisation, however, it may be too early to position for this scenario. For now, we continue to see escalation. There are also the Houthis (an Iran-backed militant group from Yemen) who are now seeming to join the conflict. The Houthis are said to have targeted two oil tankers in the Red Sea, which had become a vital workaround for crude exports from the Middle East, given that the Strait of Hormuz was closed. If the situation does not improve, yields will follow oil prices higher, and central banks may have to initiate rate hikes.
In this scenario, a hike from the European Central Bank in September seems highly likely, in line with the bank’s hawkish stance, which was confirmed in this week’s meeting. As for the Fed, we will learn more when its policymakers meet again next week.
Credit spreads are not moving much on the renewed escalation between the US and Iran. Spreads are extremely expensive, which keeps us cautious regarding high-yield credit. At current levels, we prefer credit segments that can be held through a downcycle with lower losses.