From the studio

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Thought of the day

US Treasury yields rose ahead of the release of April’s consumer price index (CPI) today, with the 10-year yield standing at 4.4% as investor expectations for tighter monetary policy kept yields elevated. Last week, a survey conducted by the University of Michigan showed that consumer sentiment fell to a fresh record low amid inflation worries.

Consensus expects headline inflation to jump to 3.7% year-over-year for April amid the ongoing Iran war and the closure of the Strait of Hormuz, up from 3.3% in March. Annual core inflation, which excludes food and energy, is also expected to rise, to 2.7%, from 2.6% in March. Monthly core inflation is estimated to go up to 0.4%, from 0.2%.

But we continue to believe that Treasury yields will fall in the months ahead, when inflation moderates and investors reprice their Federal Reserve policy expectations. Yields of benchmark government bonds in euro should also come off their recent highs.

US inflation should moderate in the coming months. We think higher energy prices may push annual headline inflation to around 3.8% in the US in the coming months, but it should moderate to 3.3% by year-end, helped by fading tariff effects and cooling core goods inflation. We also expect limited pass-through to core readings. Additionally, while US consumers now expect higher inflation in the next year, their inflation expectations for the three-year and five-year horizons remain steady. This should allow the Fed to resume easing later this year, in our view.

Soft spots in the US labor market should also support the case for further rate cuts. Nonfarm payrolls for April showed a second consecutive month of solid job growth, with hiring gains broadly distributed across sectors. But other data points from the labor report point to a softer jobs market. The unemployment rate edged up to 4.34%, and the labor participation rate declined further, obscuring softer employment growth in the unemployment rate ratio. Meanwhile, employment-to-population ratios year-to-date have declined across age groups, with drops most pronounced among younger workers.

The European Central Bank remains watchful of growth risks. We acknowledge the real possibility of near-term rate hikes by the ECB, but risks of lower growth should keep the central bank on hold for now, especially as recent data disappointed. While headline inflation in the Eurozone is also likely to rise before it moderates, we expect the year-end print to come in around 3%, which we view as insufficient to prompt a rate hike. Even if the governing council does judge that tighter monetary policy is warranted to ward off second-round inflation effects, we do not believe rates will go as high as current pricing implies.

So, we continue to believe that inflation risks are less pronounced than the market is anticipating, making current pricing in the rates markets too hawkish, in our view. This means quality bonds offer an appealing risk-reward in the current environment, as yields should fall either when investors scale back their expectations for rate hikes, or when recession risks and rate cuts come into focus. We favor short- and medium-maturity quality bonds, as well as select exposure to higher-beta segments such as emerging markets, high yield, or subordinated debt.