The recent dovish signals from the major central banks and weakening of the US dollar has helped to reduce stress in the bond market, especially at the long end of the yield curve, but also across maturities as inflation expectations continue to ease.

Fixed income and currency markets, which had been under pressure as the US dollar rose and yields tracked higher, are seeing buyers again and more positive sentiment that we believe can run for a while. This is a good development.

Yet we believe that investors should be wary about consensus views on central banks, which appear to us to be unlikely to cut rates anytime soon unless we get a significant deterioration in the labour market or an unforeseen external shock. The market is pricing in a significant amount of easing for 2024.

We don’t buy into that market consensus, and we also don’t expect to see an imminent recession, as has been the case over the last year or so. In our view, although households have been challenged by rising rates, real incomes also are increasing. Now that financial conditions are easing, this supports economic growth, which also has been supported by fiscal stimulus.

The labour market remains tight – though admittedly less so since the summer– and spare capacity is an issue. The labour market continues to be key, in our view, as even recent data showing some loosening isn’t enough to make central banks believe that inflation is beaten.

The US posted 5.2% annualised GDP growth in Q3, unemployment is running below 4% and real incomes are rising at around +1%, possibly more, depending on which inflation metric you choose. It’s true that economic growth is more anaemic in Europe and in China, but in western economies, spare capacity is scarce.

The demand side of the US economy has been robust. Fiscal spending by the Biden administration has been massive (for example, the ironically named Inflation Reduction Act) and is supportive of growth at a time of low unemployment. This helps to explain why the US economy in particular has held firm against higher interest rates.

Next year sees elections in the US, the UK, Taiwan and Mexico, among others. In fact, two thirds of the democratic world goes to the polls in 2024, and that’s not a time when governments tighten their belts or central banks tighten fiscal policy. This makes the long term fight against inflation more problematic, but keeps the stimulus in the economies for a while longer.

Market pricing at the time of writing for roughly 125bps of cuts from the US Federal Reserve for next year, and lesser but still significant cuts by the European Central Bank and Bank of England, seems to us unlikely given the current economic outlook. At some stage, we think, that unrealistic rate cut pricing will need to be addressed.

Managing fixed income assets in an unpredictable macro environment calls for flexibility. We believe that in these conditions it makes sense to seek diversification along with positive returns, in particular from a fixed income macro strategy that can offer targeted and controlled volatility along with a focus on liquidity. We think that in these macro conditions investing is about relative value and bottom-up selection for stocks, credit and sovereigns, and that this plays to the strengths of absolute return strategies.

The value of active minds: independent thinking

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