Fixed income outlook – 3Q 2024
This quarter’s summary of what to look out for in fixed income
Key insights
Key insights
In the US, the economy remains one of the strongest in developed markets globally, although some recent weakness in the labor market suggests the momentum is slowing. This was likely the clinching factor behind the Fed’s 50bp (rather than 25bp) cut in September. The well trailed first cut has now been delivered and the Fed’s own estimate for a further 50bp of rate cuts in 2024 is close to our own thinking. However, market pricing for the remainder of 2024 and 2025 already runs somewhat ahead of the Fed’s, and our own, expectations. Despite the evidence from the labor market, some domestic price pressures remain, particularly in core services. The recent fall in bond yields and oil prices also arguably ease financial conditions further. This suggests to us that a recession is the tail risk, most likely for late 2025, early 2026.
In Europe, the ECB delivered the second rate cut in September and, just like the US, one that had been well flagged in advance. Policy easing is justified by continued progress in inflation and relatively weak growth data, which highlights how much of an outlier the US is in a global context. Weak manufacturing, poor retail sales, below trend growth across the Eurozone and deflation in China all increase the likelihood of more policy easing from here. The risks of a hard landing are higher than the US, but this is not our base case. Given the different growth and inflation trajectories, we expect European markets to outperform, should ongoing US strength prevent the Fed from easing policy as far as expected by the market, and global bond yields trend higher as a result.
In China, stimulus measures announced late September suggest policymakers fully recognized the recent deterioration in economic activity and are committed to achieving their target of around 5% GDP growth for 2024. The measures on monetary, housing and equity markets will have a stabilizing effect on growth and market confidence in the near term, whilst the probability of coordinated fiscal stimulus before year-end as well as further targeted stimulus on the housing market and consumption in the next few months is now higher. Such turnaround has provided attractive investment opportunities in select greater China credits, especially given market sentiment has been on the weaker side. In the medium to longer term, whether China could return to more stable growth will largely depend on the bottoming and recovery of the housing market with further policy help.
Asset class views
Asset class views
Rates / FX
- Monetary easing cycles are underway as economic data softens, leading to lower yields and steeper curves.
- Duration assets remain attractive but appear closer to fair value given reduced scope for further declines in yields.
Investment grade
- Absolute yields should support demand for high quality credit in the event fundamentals begin to deteriorate.
- Downgrades will likely increase as growth slows, but the trajectory should be manageable and not result in added volatility.
High yield
- Spreads are high enough to absorb a reasonable increase in volatility and credit losses associated with slower economic growth.
- Default rates will approach historical averages as economic growth slows, but valuations already reflect this risk.
Emerging markets
- Valuations are attractive as countries continue to emerge from low growth, with the benefit of less restrictive monetary policy.
- Recent stimulus measures in China raise hopes of a meaningful boost to growth, an important catalyst for improvement in EM.
Investment implications
Investment implications
Rates / FX
- We maintain a long bias: in the event of economic slowdown or geopolitical escalation, yields can still fall further.
Investment grade
- Spreads should remain range bound: our bias is slightly positive with a preference for non-US corporates.
High yield
- We prefer Europe and Asia over the US and look to trade up in quality and shorter in duration in all markets.
Emerging markets
- We are constructive on Asia HY, given attractive valuations and reduced China property exposure. In EM IG, we like corporates.
- We prefer hard currency over local currency positions to limit relative return volatility tied to unexpected changes in Fed policy.
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