Mechanisms for increasing government bond yields

This week, the risk of losing risk has risen again, and the reason for the fault remains … rising yields on government bonds!

The mechanism of what is happening is that when government bond yields increase, investors turn to saving capital, reducing the risk for investments that have suffered the most from rising government bond yields. In the credit universe, the first to sell “investment-grade” corporate bonds, ie bonds with a low coupon and long life. As the supply of unwanted credit for sale grows, buyers demand higher risk premiums to own it, and spreads expand. Credit rating agencies believe that investment grade loans have lower credit risk.

Thus, mechanics makes it impossible to expand investment spreads without imitating the most speculative part of the universe – high profitability. Rising government bond yields may also make high-yielding investors more concerned about the risk of prolongation – the desire and ability of companies to withdraw their bonds on the first scheduled date – given that these companies’ ability to raise capital is lower than current. coupon of their bonds becomes impossible. Cyclic sectors and hybrid structures are unpopular in this environment. Strategists, meanwhile, are stifling animals, explaining that inflation remains high, which is bad news for corporate profits, and that low-income companies should be sold. They argue that the best course of action is for banks to aggressively raise interest rates to slow the economy and increase unemployment – then the same strategists sell consumer cycles.

There is a simple solution to stop the dynamics of risk: government bond yields must stop growing. This week we had two key events that were not part of the decision. Initially, at an ECB meeting, President Lagarde announced that the asset purchase program (APP) would end in July and that the ECB would raise interest rates by 25 basis points (for the first time in ten years) in July. It is best to continue to raise interest rates at 25 basis points per month, so without a meeting in August, interest rates are likely to rise by 50 basis points in September. According to updated ECB economic forecasts, growth has been revised downwards and inflation has been revised upwards. Inflation is now expected to remain above the ECB’s target of 2% over the forecast horizon, reaching 2.1% in 2024. This forecast has raised concerns among investors about the long bullish cycle. Next we had US Consumer Price Index (CPI) data. Core inflation accelerated, and both headline inflation and core inflation exceeded consensus expectations (year on year, the CPI was 8.6% versus the consensus 8.3%, the core CPI was 6.0% vs. 5.9% for the consensus). The market response was expected to grow by 25 basis points over the next 12 months. Therefore, cancellation reactions continue. Despite all this inflation, American households fortunately have a healthy balance with a surplus of savings of $ 2.4 billion. We believe that these deferred savings will continue to sustain growth; we still don’t think the United States will enter a recession in 2022.

06/20/2022  Excess savings
Inflation is rising, but the US savings surplus is $ 2.4 trillion
Source: Federal Reserve, Department of Commerce, Goldman Sachs Global Investment Research, May 30, 2022.

This material should not be construed as a forecast, research or investment advice, nor is it a recommendation, offer or call to buy or sell securities or to pursue any investment strategy. The views expressed by Muzinich & Co. are effective as of March 2022 and are subject to change without notice.