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Fixed Income
Global bond yields moved moderately higher in the first quarter of 2024, following the sharp fall in yields the previous quarter. Expectations for the timing and magnitude of interest rate cuts in 2024 have been diluted in the face of more resilient labour and manufacturing economic data as well as a slowdown in the pace of disinflation. However, the clear direction of travel is for a shift to an easier policy environment globally, and this should be a tailwind for duration-related assets.
Consensus expectations are now for a soft landing for the global economy given continued disinflation alongside resilient growth and labour markets, and there is the potential for global growth to catch up with the US as global manufacturing recovers. Expectations for rate cuts have been pushed back to June, with fewer rate cuts forecast than at the start of the year. Financial markets have now priced in around 70 basis points (bps) of rate cuts in the US and the UK and 90 bps in Europe. This represents a shift in relative expectations with Europe moving from the least to the most in terms of projected rate cuts. Also of note, Japan confirmed its expected shift in policy in March, moving away from negative interest rates for the first time in 17 years and abandoning its yield curve control policy.
We believe the market is underestimating the risk of two possible scenarios: a hard landing and a prolonged period of stickier inflation. The lagged effect of higher rates could yet result in a hard landing, while a prolonged period of stickier inflation could limit the flexibility of central banks.
Our strongest conviction within the global rates universe remains curve steepener positions which we expect to generate positive returns and could also mitigate against the risk of investing exclusively around the binary outcome of hard versus soft landing. We favour the US curve steepener trade as it is likely to outpace European or UK steepeners in more adverse scenarios. In terms of relative duration positioning, our view is more balanced given market pricing leaves little margin for error. We also retain a strategic underweight in Japanese bonds. It remains to be seen how the financial markets will respond to the evolving policy stance in Japan, and more substantial policy adjustments which are expected at some point.
Major curves remain inverted offering opportunity for steepening positions to add value across projected scenarios
As at 29 March 2024. Chart shows 2s10s curves for major markets.
Source: Bloomberg
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