Unconstrained fixed income views: January 2024

We assess the current macroeconomic environment, and where it might be heading by looking at the likelihood of various global economic scenarios.

Over the past month, we have increased the possibility of a soft landing and reduced the chance of a hard landing.

While risks of a hard landing haven’t vanished, a much-improved inflation outlook, an easing of financial conditions (which makes life easier for both consumers and businesses) and signs of stability in key leading indicators (bank lending being one such indicator) have led us to reduce the chances of this occurring.

The chances of hard landing are diminishing

Source: Global Unconstrained Fixed Income team as at 22 January 2024. 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.

The times they are a-changin’

Nowhere is this truer than with regards to inflation, where the slowing pace of price rises has gained momentum. Core metrics, on a six-month annualised basis, now hover close to 2% targets for both the US and the eurozone.

Furthermore, key drivers such as wage growth in the US continue to trend down and leading indicators such as the quits rate (a measure used by economists that represents the percentage of employees in a workforce who voluntarily leave their jobs over a given period) provide optimism that further progress can be made on this front.

All this has allowed policymakers to refocus their attention away from tightening monetary policy conditions to easing them.

The changing tone of central banks is most clear at the US Federal Reserve (Fed). For the first time since the tightening cycle began in 2022, the median dot (which represents the median projection of Federal Open Market Committee (FOMC) members for future interest rates) for the end of 2024 has moved downward compared to the previous projection. This is, indeed, a pivotal moment.

Changing of the guard(s)

A greater possibility of a soft landing is also in line with our improving cyclical growth scores for the US, eurozone and the UK. Indications of basing and an upward shift, coupled with a more favourable outlook due to the easing of financial conditions, are most apparent in the manufacturing sector, given its highly cyclical and capital-intensive characteristics.

A hard rain’s a-gonna fall? Maybe not

The ability of central banks to ease policy, due to lower inflation, is a key factor in the potential for a soft landing. However, the market has swiftly factored in an easing cycle, suggesting that the maximum effect of monetary policy tightening may already be in the past. As such, we have left our no landing probability unchanged from last month but have reduced the risk of a hard landing.

And what does this all mean for portfolio positioning?

Against this backdrop, yield curve steepening trades (for example, trades which look to capitalise on shorter bonds outperforming longer dated bonds) remain a favoured express of our views in rates.

While in terms of asset allocation we prefer high quality credit, remaining very positive on securitised credit, covered bonds and agency mortgage-backed securities. Elsewhere, US investment grade (IG) credit offers unattractive valuations, and we continue to prefer European IG instead.

In the foreign exchange market (FX), an expected improvement in the global manufacturing cycle as 2024 matures keeps us negative on the dollar, while we upgrade our view on emerging market currencies and selected cyclical currencies such as the UK pound and the euro.