PRU: Monetary policy shift benefits bond market, bond yields may see more volatility

Bank of China PRU Asset Management stated that signs of economic growth slowdown and easing inflation pressure provide a backdrop for central banks around the world, especially in Europe and the United States, to gradually exit tight monetary policies. This will create a favorable environment for bond markets in relevant regions. At the same time, with the normalization of the Bank of Japan's policy, Japanese bond yields may face upward pressure more easily. Although historically policy shifts have been favorable for bonds, the process will not be smooth sailing. The bank believes that the market will continue to be volatile, and investors should carefully examine economic data developments and ongoing geopolitical tensions. Recent economic data shows that despite some signs of slowing in the US economy, it remains robust. Supported by strong consumption, the US GDP growth rates for the second and third quarters were 3% and 2.8%, respectively. Additionally, although local manufacturing performance was weak, the US Institute of Supply Management (ISM) and Purchasing Managers Index (PMI) data both showed a strong performance in the local service sector. Meanwhile, although the unemployment rate rose slightly to 4.2% in November, both non-farm employment and average hourly earnings were higher than expected, reflecting the resilience of the labor market. On the other hand, the easing of local inflation pressure has also provided a backdrop for the Federal Reserve to gradually exit tight monetary policies; after reducing interest rates by 50 basis points in September 2024, the Federal Reserve once again reduced interest rates by 25 basis points in November. However, market expectations for continued interest rate cuts by the Federal Reserve have decreased, mainly due to Trump's re-election (Trump 2.0). Trump 2.0, along with Republican control of both houses of Congress, has increased uncertainty about US policy prospects. While new tax cuts and possible easing of regulations under a cohesive government may offset each other, Trump's proposed stricter immigration policies and tariff hikes could lead to a slowdown in growth. Additionally, if new tariff policies are implemented, inflation may rise, potentially causing the Federal Reserve to delay its return to a neutral policy stance, although the overall impact on the neutral policy rate remains unclear. At the post-meeting press conference of the Federal Open Market Committee (FOMC) in November, Federal Reserve Chairman Powell emphasized that the current federal funds rate is still far above the neutral rate. In addition, some economic models, such as the Holston-Laubach-Williams and Laubach-Williams models, estimate the actual neutral rate to be around 3% under the assumption of a 2% inflation rate. Meanwhile, the dot plot released by the Federal Reserve in September shows that officials estimate the median long-term policy rate to reach 2.875%. Based on these data, unless significant unexpected events occur, the Federal Reserve's view of further interest rate cuts in the future has been reinforced. In fact, the CME Group's FedWatch tool in late November showed that market participants believe there is over a 40% chance that the Federal Reserve will leave rates unchanged in December, with expectations for a 25 basis point rate cut exceeding 90%, meaning that rate cuts have almost once again become a market consensus. Since the Federal Reserve's first rate cut in September, US Treasury yields have rebounded from their lows, a phenomenon that deviates significantly from past trends following rate cuts. Considering the Federal Reserve's expected further implementation of loose monetary policy in the future, the bank estimates that the upside potential for short-to-medium-term bond yields is limited. However, facing the ongoing expansion of the US budget deficit, the US Treasury announced that it will increase the size of bond auctions. Since mid-2023, the issuance size of US Treasury bonds each quarter has exceeded $300 billion. Therefore, long-term bond yields may exhibit more volatile trends in the future. Regarding the credit market, the bank continues to adopt a cautious attitude, as current valuations seem to underestimate the risks of potential economic downturns and geopolitical uncertainties. Prudent credit selection and flexible management of the duration will be key to strict control of bond portfolio risks.