Falling rates: The bond market’s new landscape in the Eurozone  

Interest rates have started to decrease in the Eurozone. It is expected that the interest rates will continue to go down during the next year, until December, and stabilize after a few cuts. 

We can see the forward interest rates for the EUR in the following chart: 

Source: IBKR TWS. Past performance is not indicative of future results

The expectation in the near term is to lower rates by about 2% from current interest rate levels. The basic assumption is that when interest rates fall, bond prices rise, and vice versa. 

This fact implies that bond prices should increase during that time although this is not as straightforward as it may sound because some of this decrease has already been discounted in current prices. Bond prices have rallied since June, as we can see in the chart below, which compares of the iShares Core € Govt Bond UCITS ETF (IE00B4WXJJ64), iShares Core € Corp Bond UCITS ETF (IE00B3F81R35), and iShares € High Yield Corp Bond UCITS ETF (IE00B66F4759): 

Source: IBKR TWS. Past performance is not indicative of future results

Bonds with higher risk showed a better performance because it is easier for companies to service their debt with more flexible credit facilities. Bond prices are primarily affected by interest rates and credit risk. It is also important to consider that longer term bonds are more sensitive to interest rate fluctuations due to their higher duration and potential for significant changes in rates over their time to maturity. 

During 2022, inflation jumped by more than 10% and central banks responded with an increase in interest rates, as it attempted to cool down the economy by making credit more expensive, thus forcing investors and consumers to take these higher rates in consideration when making their financial decisions.  

Today, inflation looks to be under control, with rates close to the central bank’s target, but there is a new concern that we may be closer to a recession. The yield curve has been inverted in the Eurozone for a prolonged period, and this is one of the most reliable indicators for a recession.  

Macro numbers in Europe are weak with the last Eurozone GDP (QoQ) of only 0.4% in the Q3 and a PMI composite of 48.3 in November (a score of more than 50 indicates an expansion and a score of less than 50 indicates a decline). Germany, the biggest economy in the area had a negative Q2 of -0.1%(QoQ), slightly better Q3 0.01% and PMI 47.2. These numbers may be interpreted as the beginning of a deteriorating situation in the future. Moreover, the Ukraine-Russian and the Middle East conflicts are always in the spotlight and could escalate at any time. 

In distress situations, corporate and high yield bonds are more vulnerable than government bonds because they carry higher default risk and investors tend to move to safer assets.  

The future performance of European fixed income will depend on how much interest rates fall if inflation is kept under control and if economic conditions continue to slow down, among other factors. The onset of declining interest rates marks a significant shift in the fixed income market landscape.  

At IBKR we have more than 1 million bonds available, you can find all the information about our bond offer int this link: https://www.interactivebrokers.ie/en/trading/products-bonds.php