Investment Viewpoint: Bond market volatility returns

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Markets and macro insights with Bernard Swords, Chief Investment Officer

Key takeaways:

1. Markets came under pressure last week amid US bond market developments and Middle East tensions.
2. Concerns over US debt levels weighed on bonds and the US dollar, while higher oil prices continued to support energy markets.
3. European economic activity remained resilient, with manufacturing showing signs of improvement, while the picture in China was less encouraging.
4. Portfolio impact remains limited as we do not hold exposure to US government bonds, though currency movements are being closely monitored.

How did markets perform last week?

• Financial markets experienced a more challenging week, with both equity and bond markets coming under pressure. Investor attention was focused on developments in the US bond market, ongoing tensions in the Middle East, and a mixed but generally encouraging set of economic data releases.
• The principal market story of the week was developments in the US government bond market. The US Treasury announced changes to its debt management strategy, increasing its purchases of longer-dated bonds while relying more heavily on the issuance of shorter-term debt. Some investors viewed this as a step towards influencing longer-term borrowing costs, raising concerns about potential intervention in the bond market. While the announcement initially provided some support to longer-dated bonds, this proved short-lived and bond prices across the market weakened by the end of the week. Investors appeared unconvinced that the measures were significant enough to address the larger structural issues facing the US public finances.
• One consequence of these developments has been renewed weakness in the US dollar, which has fallen back towards some of its weakest levels against the euro this year. Questions about the long-term sustainability of US government debt levels have resurfaced, although this is not a new concern for investors. While we believe the US dollar may continue to move towards the weaker end of its long-term trading range against the euro, we do not currently expect a significant or sustained departure from the broad range that has characterised currency markets over the past decade.
• Geopolitical risks also remained an important factor for markets during the week. The conflict in the Middle East continues with no obvious path towards a lasting resolution, creating ongoing uncertainty for investors. As a result, oil prices have continued to move higher, with Brent crude rising above $90 per barrel. While this remains below the highs reached earlier in the year, the upward trend is contributing to market concerns. Energy markets and related commodity sectors have been among the strongest-performing areas this year, reflecting the continued impact of geopolitical tensions on global supply expectations.

How does this impact our positioning?

• From a portfolio perspective, movements in the US bond market have limited direct impact on us as we do not hold exposure to US government bonds. Currency movements are of greater relevance, and we continue to monitor developments in the US dollar closely.

What did the key economic data releases tell us about economic growth?

• Economic data released during the week provided further evidence that developed economies are holding up relatively well. In the euro area, business activity surveys improved again, with the composite Purchasing Managers’ Index (PMI) rising to 52.1, comfortably above the level of 50 that signals expansion. Encouragingly, much of the improvement came from the manufacturing sector, which has faced significant challenges from energy costs this year. The data suggests that economic activity across the region remains resilient despite the uncertain global backdrop.
• The picture in China was less encouraging. Industrial production growth continues to slow and retail sales are only recording modest year-on-year growth.
• These trends reinforce our view that economic momentum in parts of Asia remains weaker than in many developed markets. We continue to have greater confidence in the outlook for US and European economic growth relative to China and several other Asian economies, and last week’s data supports that assessment.

The week ahead: what to watch out for

Looking ahead, the economic calendar is relatively light. As a result, market attention is likely to focus on NVIDIA’s latest results. Investors will be looking closely for further evidence that the artificial intelligence investment cycle remains strong and for indications of how corporate spending on AI-related technologies is evolving. As has been the case for much of this year, the market’s reaction to developments in the AI sector is likely to have an important influence on broader market sentiment.

Alongside earnings news, investors will continue to monitor developments in the Middle East closely. With geopolitical tensions elevated and markets sensitive to changes in the economic outlook, volatility is likely to remain a feature of investment markets in the weeks ahead. Despite these uncertainties, the resilience of developed economies continues to provide an important source of support for markets and for our longer-term investment outlook.