Investment specialists are singing from a common hymn book in predicting the world is on a path to lower inflation and treasury yields, though they carefully call attention to possible transitional effects, Investment Officer heard while covering two recent investment events in Luxembourg. The United States, facing a fractious election later this year, is “ahead of a very exciting spending cycle” in manufacturing because of major public investment.
J. Safra Sarasin Bank equity strategist Wolf von Rotberg sees the year to come as “the mirror image of 2023,” explaining that rates “should come off.” Speaking of treasury yields, he said they had probably peaked and “will likely go down throughout the year.”
With markets pricing in rate cuts, he said he agreed that the Fed will likely ease, but observed that “they will have to wait somewhat longer until they can cut because they need to see that the labour market is cooling.” While he said there had been an adjustment or softening of inflation, it was “not enough to call it a victory.”
End in view
Over at Capital Group, fixed interest income investment director Flavio Carpenzano also noted the market consensus on rate cuts in 2024. While the inflation fight may not be over, he noted that “the end appears in view.” He said he believes “headline and core inflation will be within striking distance of the Fed’s 2% target in the next six to 12 months.”
However, Carpenzano issued a cautionary prediction that “looking at the forward curve, the market expectations of rates in the US treasury yield curve in a year’s time shows that the front-end rates will go down, but the long end of the curve is currently expected to stay at these levels”.
If market expectations of lower yields are not fully realised, investment-grade corporate bonds will potentially have positive returns driven by the high carry, he explained.
Fiscal expansion
J. Safra Sarasin’s Rotberg said he expects the cycle in the US to slow because there were very specific reasons for its strength in 2023. He pointed to what he termed “a pretty substantial fiscal expansion.” “Fiscal” refers to the use of government spending and tax policies to influence economic conditions.
“The government went all-out to stimulate the economy at the same time as the Fed was hiking rates,” he said.
Christophe Braun, Capital Group’s equity investment director, said in the US “we are potentially ahead of a very exciting spending cycle when it comes to manufacturing,” based on the country’s 1 trillion industrial spending bill signed in 2021. “We believe that this is only materialising now, in 2024.” He pointed out that contracts based on the new spending bill took time to process.
Lucky break
The drop in personal income tax revenues affected US fiscal accounts. “It was two components which the government doesn’t really have a lot of control over in the short term,” said Rotberg. “They also got a bit lucky in this regard.»
Major European economies, notably Germany, aren’t doing so well, explained Rotberg. Nevertheless, explained Carpenzano, deficit spending is also increasing in Europe “for financing energy transition, for financing healthcare’, he said. “This government spending is going to generate more supply in the long end of the government bond market, which puts more pressure on the 10-20 years.”
Talk of interest rate cuts has become steady in the financial press, which has worried some who had talked up fixed-interest investing. At Capital Group, fixed interest income investment director Flavio Carpenzano pointed out that November and December 2023 were “among the best months in history in terms of returns”, and explained that fixed income’s journey has another leg to run – but emphasised not waiting too long.
Room to cut
“Real rates are higher and central banks have significant room to cut rates in 2023,” said Carpenzano. “Nominal and real rates are still well above historical average. Even if rates are not likely going back to the previous average, they still have more room to go down.”
Reflecting his investment focus, Carpenzano said “bonds performed well across the board as yields fell and credit spreads contracted, with most global bond asset classes returning high single to low double digits, strongly outperforming cash.”
In his message to investors, he emphasised the need “to be active and flexible to capture potential bounces in volatility and dislocations.” Noting that spreads in investment grade corporate bonds remain relatively tight, he said active managers can seek opportunity in the elevated level of dispersion.
The injunction to stay diversified is key to investors seeking high yield and income, he said. There’s no need to concentrate one’s risk in complex and risky asset classes – read alternative investments – since even higher quality bonds offer high yield today, he argued.
Further reading on Investment Officer:
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- Misjudging Fed interest rates could be a costly mistake