Outlook 2024: Bond markets caught between economic weakness and geopolitics

• Economy: Inflation shock, geopolitical crises and high interest rates are a burden
• Bonds: Likely three interest rate moves by the Fed and ECB
• Corporate bonds: Corporate indebtedness could rise
• Forex market: EUR/USD exchange rate trending sideways
• Gold: Correction imminent

Economy: USA more robust than the euro zone

The euro zone economy is weak with ongoing recessionary trends, particularly in Germany. Inflation will probably fail to reach the European Central Bank's (ECB) target of 2% in 2024, but it will likely come close. The US economy is currently more robust, even though the November labor market report points to an economic slowdown.

In addition to several geopolitical crises, the markets are likely to focus on the US elections in November. The analysts at Metzler Capital Markets do not expect a quick solution to the Ukraine conflict next year either. The situation in the Middle East is likely to also remain tense and cause considerable uncertainty. Additional risk factors could arise if Donald Trump becomes the Republican Party's presidential candidate, as a renewed presidency would likely fuel geopolitical risks further. In connection with the Middle East conflict, Metzler experts see the greatest risk for oil prices and energy supply.

Bonds: First interest rate cuts at mid-year

After significant interest rate hikes in recent months, the analysts at Metzler Capital Markets believe interest rates have peaked. However, they are likely to remain at peak level for a while before the ECB loosens its monetary policy. The US Federal Reserve and the ECB are likely to initiate first interest rate cuts at mid-year in 2024. "In view of the positive inflation trend and the latent weakness in demand in the euro zone, the ECB will have to respond with interest rate cuts by the end of the second quarter," explains Eugen Keller, bond and forex expert at Metzler Capital Markets. Keller expects three interest rate cuts of 25 basis points each in both currency areas in 2024. "The yield curve for both European and US government bonds with maturities between two and ten years could normalize by the end of 2024, albeit with slightly higher interest rates at the ultra-short end," the Metzler expert expects. German Bunds and US Treasuries with a ten-year term are likely to have already reached their peaks of 3% in Germany and 5% in the USA, respectively. The downward trend will probably accelerate next year. Metzler analysts expect a yield of 2.2% for ten-year Bunds and 3.9% for ten-year US Treasuries by the end of 2024.

Corporate bonds: Weaker operating performance, but narrower spreads

"We expect fundamentals to weaken again next year. For companies, we expect a decline in demand and increased competitive pressure on the sales figures," says Stoyan Toshev, financial analyst at Metzler Capital Markets. According to Toshev, this will cause insufficient redistribution of higher costs and thus put additional pressure on margins. Due to lower earnings, the degree of corporate indebtedness is expected to rise.

High interest rates have already been affecting companies for several quarters, although the impact on bonds varies greatly depending on maturity. "We expect higher refinancing requirements coupled with higher costs. This will lead to a reduction in the interest cover ratio and additional burdens for companies," says Metzler analyst Juliane Rack. The default rates for bonds have rebounded slightly from historic lows. Rack expects further defaults in the coming year due to the weak economy but does not see a real crisis.

"For companies, however, the geopolitical risks could once again have a negative impact on supply chains and lead to declines in sales and production if goods that are high in demand cannot be produced," says Rack.

Forex market: The euro has an advantage over the US dollar

Metzler experts also see very narrow fluctuation bands on the forex market in 2024. In an environment of low volatility, the EUR/USD exchange rate is likely to move sideways, as the factors influencing both currencies largely balance each other out. The advantages of the US dollar from growth and interest rate differentials will be offset by a current account deficit and overvaluation based on purchasing power parity in the euro zone. Currency expert Eugen Keller sees the EUR/USD exchange rate at 1.10 at the end of 2024.

Gold: The peak is ending

Physical gold has long performed better than other asset classes like equities, bonds and other commodities. However, the effects of inflation and geopolitical tensions have also been evident here, and Metzler experts expect a correction towards USD 1,850 per fine ounce of gold next year.