By François Rimeu, La Française Asset Management Strategist

February's bond correction on the short end of the curve needs to be tempered by macroeconomic figures

The bond correction continued in February with quite violent movements in the short end of the yield curve, both in Europe and the United States. The reason? In both regions, inflation figures exceeded expectations, prompting central bankers to reassert, in a somewhat more vocal manner, their reluctance to lower interest rates.

Simultaneously, macroeconomic figures tended to reassure investors, partly explaining the confidence exhibited by our central bankers last month. Among these figures, we can mention, in no particular order, the U.S. job creations of 353,000 against an expected 185,000 in February, as well as manufacturing PMIs confirming their recovery across the globe, including the Eurozone (excluding Germany so far).

It is necessary, however, to note several things regarding this bond correction:

- The scenario envisioned by inflation swaps remains the same: there is little (or very little) inflation risk in the medium to long term. The 10-year Euro inflation swap is currently at 2.18% and 2.47% in the United States. This is higher than pre-COVID levels but quite close to the 2010-2015 period and consistent with central banks' targets. Central banks are still seen as credible by the markets.
- The longer end of the yield curve remained very subdued, with volatility, while historically very high, still seeming to be trending downward. This limited reaction seems logical considering the benign inflation scenario for the markets. Finally, risky assets performed very well, much to the surprise of many participants. Again, this seems consistent given the relative calmness of the longer end of the curve (nominal and real).
- The markets are now anticipating rate cuts cycles that are set to begin only in June, which aligns with central banks' communications. Except for significant surprises regarding inflation, this should not change much before the end of May and should allow volatility to continue its slow decline.

Meanwhile, equity markets are enjoying their best time, with significant gains over the past month. It is worth noting the resurgence of Chinese stocks (+8.55% for the MSCI China) and the strong performance of small-cap US stocks (+5.52% for the Russell 2000), while sectors related to commodities continue to underperform indices quite widely. Strong earnings seasons in the United States have helped support valuations.

Global Economy: Banks, Gas Prices, and Our Outlook

Banks have also contributed to supporting risky assets. Indeed, the specter of a new banking crisis had resurfaced last month, both in Europe (Deutsche Pfandbriefbank, DPB) and across the Atlantic ( New York Community Bancorp , NYCB), due to excessive exposure to US commercial real estate. There has been no contagion so far, and the situations seem to be settling quietly, with a group of renowned investors at the helm of NYCB (including Mnuchin, former Treasury Secretary) and reassuring results for DPB.

Meanwhile, gas prices have sharply declined in February due to extremely mild temperatures, leading to reduced demand. Over the past six months, the decline has been steep and could continue in the medium term. Europe is expected to increase its gas exchanges with its partners (Qatar, UAE, Mexico, United States) by 30% per year from 2025, thanks to investments made following Russia's invasion of Ukraine. This drop in gas prices will logically affect fertilizer prices and consequently agricultural commodity prices in the coming months and quarters.

Our convictions remain largely the same as last month: manufacturing activity will continue its rebound and gradually lead to upward revisions in growth prospects (Europe, EM excluding China). This should be beneficial to equity markets and allow certain sectors to reverse a very negative trend over the past 18 months (S&M caps, industrials, etc.). Interest rates should be slightly downward-oriented with volatility also decreasing, as long as the markets do not change their long-term inflation scenario or central bankers do not drastically alter their discourse (for example, a revision upwards of the neutral rate).

March / April Outlook

We remain generally positive on risky assets despite recent performance. Investor positioning is increasing, but it is not yet extreme, which should continue to attract positive flows in the face of improving growth figures.