Capital Ideas^™ 
Investment insights from Capital Group

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Pramod Atluri:

I'm expecting a soft landing with growth slowing for the rest of the year, and then improving in 2024. But having said that, the risks skew clearly to the downside.

2023 has been a very challenging year to be a macro analyst and investor. There's been a lot of crosscurrents. Uh, we started the year with a lot of optimism. But then as we got into March, there was a banking crisis. We had an ongoing housing recession. Commercial real estate is, is currently in a terrible state. Um, as a result of the banking crisis, there's an expected credit crunch and the lagged effect of monetary policy tightening. So, there's a lot of negatives in the economy today. On the other hand, I talked about how we came into the year with, with a housing recession. Housing activity is starting to improve. And there’s some who think that it may have troughed. And the consumer has been incredibly resilient this year. Most of us, including myself, thought that a lot of the headwinds that I spoke about was going to take its toll on the consumer and that was gonna have the economy in a recession by now. And that has not played out that way. And payrolls have continued to be stronger.

So, there's a lot of different views on, on what's happening with the global economy and, and particularly the U.S. economy. Um, I, myself, am on the more bullish end of the spectrum. I think that the, the fact that the consumer and payrolls have remained resilient in the face of all of those headwinds means that the economy is stronger than we thought it was. When I see housing activity that's turned the corner, uh, I think that may compensate for some of the weaker activity that we expect from the credit crunch, um, as banks start to, to tighten up on lending, given everything that's happened earlier this year. 

But if inflation continues to fall along uh, the path that, that I expect, I think that's going to allow the Fed to end their rate hikes um, at some time this year. The market is expecting one to two more rate hikes. The Fed is guiding to, uh, up to two more rate hikes. I think that seems pretty reasonable. And if, as long as they go at a slower pace like they’re guiding to, I think that by the time they do two more rate hikes, we will see inflation that will have fallen to 4% or below with a very clear trend to lower. And that could lead the Fed to be able to pause um, rate hikes by the end of this year with the next move likely to be rate cuts. So, when I put all of that together, I'm expecting a soft landing with growth slowing for the rest of the year, and then improving in 2024. But having said that, the risks skew clearly to the downside.

So, given all of that, if my view is right, then I think the Fed has one to two more hikes to go. But the pace is likely to slow significantly from here.

I think the Fed's gonna remain at that higher rate for a while, maybe through most of 2024. And if inflation continues to fall, that, that'll allow the Fed to lower rates thereafter. And this is higher for longer rate view, which is different than, than what I provided in my last update. Now, my view is that rates are likely to be higher than expected for longer. Now, most of the rate move is probably done. 

And I think given all of this, it's probably time to average into interest rates. So, my portfolios are back to roughly neutral interest rate duration interest rate risk from being underweight.

And my view is that rates could probably move a little bit higher from here, maybe 25 basis points, uh, in order to, to um, fairly price in the Fed hiking one or two more times.

And if the economy does worse than, than I expect and the Fed turns more dovish, I think there's probably more upside from there.

So, in general, a core bond portfolio has a very specific mandate. When the environment isn't clear, uh, it, it makes us skew towards having a more defensive portfolio. Even though I think we may achieve a soft landing, the risk clearly skewed to the downside and valuations are no longer cheap. So in our portfolio, we are broadly back to a, a neutral credit risk portfolio focusing on higher quality agency mortgages, structured products and corporate bonds.

At the same time, we’re moving our interest rate exposure higher. And as the outlook for inflation improves and the Fed gets closer to the end of their tightening campaign, this is something that, that I think we are likely to continue to add to, um, as the year goes on. This should provide some income and, and, and diversification of the portfolio, but also provides, downside protection if growth falters.