The Global Unconstrained Fixed Income team continually evaluates the current macroeconomic landscape and potential future scenarios by assessing the likelihood of various possible global states. Over the past month, our perspective has been gradually evolving, leaning towards the increasing probability of a global soft landing. As a result, the hard landing scenario appears comparatively less probable.
Chart: Soft landing is now looking more likely
Source: Global Unconstrained Fixed Income team as at 18 December 2023. For illustrative purposes only. “Soft landing” refers to a scenario where economic growth slows, but to a sustainable rate without experiencing recession; “hard landing” refers to a sharp fall in economic activity; “no landing” refers to a scenario in which inflation remains sticky and there’s a reacceleration of interest rate hikes.
Tidings of comfort and joy, particularly in the US
There’s been a significant change in the interest rate outlook over the last few weeks. Strong markets have contributed to easier financial conditions, and the US Federal Reserve (Fed) has pivoted to more dovish rhetoric, indicating potential interest rate cuts of 75 basis points during 2024.
The emergence of some tentative signs of the global manufacturing cycle turning more positive has enabled us to raise the probability of our soft landing scenario to 70% – although we’re very conscious that markets have moved to price this outcome in recent weeks.
The US economy has been showing signs of strength, particularly in the labour market where robust jobs growth has pushed unemployment lower for the first time in several months. Inflation has also continued to decline, even though goods deflation is not yet matched by the service sectors.
We have been more pessimistic recently on the outlook for Europe and the UK, but are now moving towards a more neutral stance as we see evidence that the peak impact of rate tightening on European growth may be behind us.
Hard landing and no landing: 'a-weighing' the danger
The risks of a hard landing are still present. But while we can’t yet rule out a global recession in 2024, it certainly feels less likely than previously: the looser financial conditions we’re now experiencing should help support business activity over the coming months.
On the other side of the risk spectrum, the no landing scenario also remains a possibility. We continue to watch carefully for any signs of a reversal in the current disinflationary trends, particularly given recent data that suggests US small businesses are once again seeing rising pressure on prices.
Present positioning – 'pudding' it all together
The macro environment - subdued growth, disinflation, more dovish central banks - supports higher levels of overall duration (i.e. interest rate risk). However, it's important to acknowledge that markets have also swiftly priced in the new environment.
So, instead, we currently prefer yield curve steepeners, positions that anticipate shorter maturities to outperform long-dated bonds. This allows us to reflect the same macro views but at more reasonable valuations. We’ve also adjusted our cross-market positioning, with the Fed’s pivot towards signalling potential interest rate cuts making duration in the US more attractive than in Europe.
We remain positive on most high-quality spread sectors, with the most compelling valuations in covered bonds, securitised credit, and quasi-sovereigns. However, following recent market moves, corporate bonds are less attractive, particularly in the US. We favour European investment grade issues, which offer better value at present.
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