In light of the extended duration of high interest rates, we’re employing a carry strategy, ramping up our allocation to high-yield bonds.
Key takeaways
Inflation
Global inflation has declined since its peak of 8% during the third quarter of 2022, but it is slow to fall below the threshold of 3%. We will need to wait until 2025 to see it return to around 2.5%.
Monetary policy
Our scenario anticipates that the Fed should delay its first rate cut until December, whereas the first European rate cut could potentially come in June.
Fixed income
We are reinforcing our positioning on high yield from 3 to 4, with a focus on carry as the primary driver of performance within the asset class.
Equities
We remain confident that the market rally will continue to broaden in terms of sectors and regions.
Editorial
The search for carry
The longer-than-expected disinflationary process and increasing tensions in the Middle East undermined the equity and bond markets in April. The lingering pressure on prices alongside the resilience of the US economy suggests that the Federal Reserve will probably keep its main interest rate higher for longer. Considering these recent developments, should we reassess the validity of our ongoing scenario?
Given global inflation of 3%, our latest forecast suggests a decline to a range of 2–2.5% during the first quarter of 2025, rather than in the coming quarters as previously anticipated. Our scenario remains the same, but this revision increases the likelihood of the easing cycle starting in the second part of this year.
As an important component of inflation indicators, we are closely monitoring the fluctuation in gold and oil prices amid mounting geopolitical risks.
In response to elevated interest rates, we leverage a carry strategy to capitalise on rate differentials within the fixed-income space, recognising that the era of capital gains on credit is behind us.
As a result, we strengthened our conviction on high yield from 3 to 4.
We also adjusted our rating on Chinese equities from 1 to 2, as we are tactically more constructive. However, we remain cautious due to the lack of visibility and corporate earnings transmission to shareholders.
Strategy
Look for a near-term peak in yields going into summer
April saw further active conflict in the Middle East, raising inflationary concerns, weak US Treasury auctions, and a nearly USD 500 billion liquidity drain, leading to a surge in US Treasury yields and a nearly 5% sell-off in US and global equities, a near repeat of the backdrop that challenged investors in October 2023.
Fortunately for investors, as in October 2023, a series of catalysts are set to emerge going into the summer that should reverse these headwinds as anticipated in our April report.
Starting on 1 May 2024, investors can look forward to the Federal Reserve announcing a “tapering” of the pace of its balance sheet reduction begun in 2022. As outlined in the March 2024 Fed minutes, the US central bank should begin reinvesting as much as an additional USD 30 billion per month in US Treasury securities, or as much as USD 180 billion in incremental liquidity through to year-end as this tapering is implemented.
This comes as the seasonal liquidity drain associated with the American tax season in April fades and the USD 100 billion liquidity drawdown associated with the winding up of the emergency Silicon Valley Bank facility reaches its completion in May and June.
Looking back to 2022, these swings in liquidity have been instrumental in driving medium-term moves in both equity and bond markets.
Expanding liquidity profiles, which we anticipate to begin in June, have – as in October 2022 to May 2023 and November 2023 to February 2024 – coincided with both strong returns in global equities and falling US Treasury yields.
Therefore, assuming geopolitical tensions once again stabilise as they did in November 2023, this pivoting liquidity regime should mean the year-to-date rise in 10-year US Treasury yields should peak in the coming weeks and converge back towards our 4.5% target established in November 2023 in our 2024 Investment Outlook entitled, Back to the Future.
For global equity investors, this should offer a window of opportunity, as earnings momentum outside of global technology begins to re-accelerate moving through the summer, broadening the sectoral and geographic participation in the equity market rally year-to-date.
