Key Insights

  1. In the US, the economy is proving resilient in the face of the policy tightening cycle that began in 2022. The Fed members are not hurried to cut rates in light of some slowing in the rate of disinflation during 1H24, and hence their most recent projections imply just one cut by year-end. Market pricing is slightly more optimistic, implying two cuts that are skewed to late Q3/Q4. Our base case is for at least 1-2 cuts in the remainder of the year, but any Fed policy moves will not now presage the start of a lengthy rate-cutting cycle which, in the past, was usually driven by recession or financial market stress. Fed action in coming months is more likely to reflect ‘policy fine-tuning’ to achieve their mandate.

  2. In Europe, the ECB has delivered the widely anticipated 25bp June rate cut. This was justified by the sharp drop in inflation and relatively weak growth data which highlights how much of an outlier the US is in a global context. However, just as in the US, this is not expected to presage the start of a lengthy cycle of progressively lower rates, with just 1-2 cuts priced in by year end. Given the different growth and inflation trajectories, we expect European markets to outperform if ongoing US strength meant that the Fed was unable to ease policy and global bond yields trended higher.

  3. In China, some improvement in the economy relative to last year is clearly evident, although this is more obvious in industrial production and exports than households to date. The authorities accept the need for ongoing fiscal and monetary policy support with close attention to macro-prudential risk management in the financial sector. Strong progress on all these fronts to date will be undermined if the authorities execute poorly on existing policies or fail to expand measures over time. Our base case assumes continued good progress and our outlook is more positive than the investment community consensus.

Asset Class Views

Rates/FX

  • Rate hiking cycles have peaked and cuts are now materializing, with the US expected to follow Europe’s lead in 2H 2024.
  • The risks of a hard landing are growing in the Eurozone where the ECB mandate is focused solely on inflation.

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.
  • China’s reopening and expansive macro policies are an important catalyst for improvement in Emerging Markets.

Investment Implications

Rates/ FX

  • Policy cutting cycles should be positive for rates, particularly at the front-end where risk-reward is most attractive.

Investment Grade

  • Spreads should remain range bound: our bias is neutral with a preference for non-US corporates.

High Yield

  • We prefer EUR high yield and short duration high yield, looking to add exposure in select industries where conviction is higher.

Emerging Markets

  • In Asia, we are becoming more constructive on China HY given valuations. 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.

S-07/24 NAMT-1303

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