Inching closer towards rate cuts

Last week’s central bank meetings confirmed our long-held thesis that they can now point to inflation slowing down and are at or near the end of this tightening cycle. At the same time, central banks remain complacent that a global soft landing can be achieved.

In our view, as we go through this year the impact of the massive monetary tightening of the last twelve months will increasingly be felt on global growth, which will lead to decelerating inflation and the likelihood of rate cuts towards the end of the year. Government bonds therefore remain very attractive at these levels, particularly in higher yielding markets such as the US and Australia.

Our preference is for government bond markets where we believe the central bank is coming to the end of its tightening cycle. This includes the US, Australia, New Zealand and South Korea. We’ve seen the likes of Canada, Brazil, Mexico and Chile go on hold. We believe this list is set to grow in the coming weeks and months. As an aside, it’s worth mentioning that there is a large short position in US Treasuries amongst the speculative community. We believe that these are legacy short positions from last year implemented by large macro hedge funds. If the inflation picture continues to improve, these shorts are likely to capitulate and push yields down somewhat further.

The Federal Open Market Committee’s (FOMC) decision and statement broadly came out as markets expected, although with some nuances. The Fed hiked rates by an additional 25bps to 4.50%-4.75% as priced by the market. The statement continued to highlight the need for further tightening in the coming months, but the tone of Chair J. Powell during the press conference was probably modestly more dovish than the market expected.

Powell highlighted multiple times how the Fed recognizes (and welcomes) that the “disinflationary” process has started. This applies especially to goods and should soon apply also to shelter. Core services ex-shelter remain instead the main concern for the Fed. The usual mention to the lags of monetary policy effects was the main justification behind the need to look at future data prints to better define the path going forward. Overall, this is consistent with our view of a progressively less hawkish Fed in the coming months. Leading indicators (e.g. see last ISM Manufacturing Purchasing Managers’ Index ) continue to highlight weakness, but the job market, at least on the surface, remains stubbornly strong, with job openings reversing some of the losses seen in the last months. We continue to believe this strength might be overstated, as headcount cuts become a constant in guidance from corporate America. Investment implication: still constructive on US Treasuries and find good value in the US curve at these levels.

In the UK, the Bank of England (BoE) delivered the expected 50bps rate hike but highlighted how increases might follow in future meetings. At the same time the committee revised previous bleak economic forecasts, recognizing how recent developments might make recession in the UK less certain and in any case less sharp and less prolonged. Overall, markets are for the moment perceiving the message as marginally more dovish, with gilts performing relatively strongly after the statement. We still see the UK inflation and growth picture as more uncertain versus other areas of the world and for the moment we prefer to express our rate views elsewhere.

Finally, in the Eurozone, the European Central Bank (ECB) also delivered the expected 50bps rate hike, bringing the deposit facility rate to 2.5%. In a somewhat mixed messaging, President Lagarde expressed her intention to stick to the 50bps pace also in the March meeting, but on the other hand continued to describe a “meeting-by-meeting” approach dependent on upcoming data. Risks to growth and inflation become more balanced thanks to the positive developments in energy markets. Overall market reaction was once again positive, with Bund yields shifting broadly lower and peripheral spread tightening. We think that the outlook for the Eurozone rates outlook remains uncertain. At the same time, supply dynamics for the coming quarters look pretty adverse for investors, with a lot of new net issuance coming to the market. Also, in this case we prefer to express our macro/rates view elsewhere.