JPMorgan Asset Management sees bond value as energy prices fall, favors European government debt

Falling energy prices are strengthening the case for bonds, with European government debt potentially benefiting more than US Treasuries, according to Ian Steely of JPMorgan Asset Management.

In a Bloomberg interview on November 5, Steely said the drop in oil prices was the main force driving bond yields lower. Despite the recent rally, yields remained elevated, offering value in owning bonds and taking duration exposure, he said.

Steely identified two other supportive factors: limited scope for fiscal conditions to deteriorate further and a possible slowdown in the AI sector. Slower AI activity could weigh on economic growth and debt issuance, both potentially favorable for fixed income. Still, he emphasized that falling oil prices had dominated the market response.

The outlook depended heavily on developments in the Middle East. Steely said energy prices had appeared elevated relative to oil flows through the strait, reflecting fears of renewed conflict after the midterms. Those fears had eased for now, although the situation remained uncertain. The cost of maintaining American troops in the region and the strain of the blockade on Iran's economy made a return to negotiations appear the most likely direction, he said.

Inflation pressures this year had largely reflected supply factors, particularly energy costs, Steely said. Central bankers were not seeing the degree of transmission into underlying inflation that would concern them, so lower headline inflation should support bonds. Expected productivity gains could also help, although he stressed that the outlook remained tied to energy prices and the Middle East.

European government bonds could benefit more because Europe is more exposed to energy prices than the US, Steely said. French and Italian government debt had posted particularly strong moves during the recent rally. He also pointed to more rate increases by the European Central Bank than by the Federal Reserve, alongside weaker economic activity in Europe.

Steely said recent portfolio purchases had included German government bonds. With lower energy prices bringing conditions closer to the European Central Bank's baseline scenario, he questioned whether tightening would exceed market expectations. Markets were pricing two further increases after two already delivered; additional tightening beyond that looked difficult to justify if energy prices remained contained, he said.