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Thought of the day

The selling pressure in global government bond markets continued toward the end of the week, ahead of key jobs data from the US due today. The yield on the 10-year US Treasury is approaching 4.7%, the highest level since April following a 13-basis-point climb from the start of this year. In the UK, the yield on the 10-year gilt is above 4.8%鈥攍evels not seen since 2008.

In addition to worries over the UK鈥檚 expansionary budget and greater government bond supply, investors remain cautious amid scaled-back expectations for how much the Federal Reserve will lower rates this year. Concerns that US President-elect Donald Trump鈥檚 policies could push up inflation and worsen the already challenging government fiscal position have also weighed on sentiment, while a traditionally heavy month for corporate bond issuance in January has added to the upward pressure on yields.

But we maintain the view that bond yields should fall as interest rates move lower, even if the Fed slows the pace of easing this year. We forecast the 10-year US yield to reach 4% by mid-2025.

US labor market conditions are easing gradually. The nonfarm payrolls expected today will provide additional clarity in gauging the health of the US labor market, after mixed signals from other data releases this week. Job openings rose strongly in October and November, but private payroll growth compiled by the ADP moderated in December. With the hiring rate and quits rate still at cycle lows, we expect the labor market to remain resilient but to soften over the year. Any evidence that points to a deteriorating labor market could put faster rate cuts back on the table.

Inflation should moderate further despite renewed concerns. Fed policymakers in December believed that the upside risks to the inflation outlook had increased, according to the minutes published this week, noting that the effects of potential changes in trade and immigration policy could see inflation take longer than previously anticipated to fall toward its 2% target. However, they noted that disinflationary progress continued to be apparent across a broad range of core goods and services prices, and that they expected the rise in housing services prices to moderate further. With Trump鈥檚 potential tariffs more likely to cause a one-time increase in the price level, rather than sustained higher inflation, we expect US core inflation to slow to below 2.5% before mid-year, allowing the Fed to start cutting rates again.

Recent Fed commentary supports additional rate cuts. Recent messages from Fed officials suggested that policymakers see 鈥渕ore work to do on inflation,鈥 although comments in recent days reflected a range of perspectives on future monetary policy. Governor Michelle Bowman advocated for halting rate cuts, while regional presidents Susan Collins and Patrick Harker expressed confidence in gradual reductions later this year. Governor Christopher Waller earlier this week highlighted that more cuts will be appropriate. We continue to believe that the current policy rate remains restrictive and is a headwind to economic growth and inflation, and expect two 25-basis-point rate reductions this year, most likely in June and September.

So, we maintain our Attractive rating on high grade and investment grade bonds, and recommend investors lock in currently attractive yields as they redeploy cash in a lower-rate environment. We also see value in diversified fixed income and equity income strategies to enhance portfolio income.