Market Insights at a Glance
We believe that ongoing disinflation allowing scope for central bank easing, resilient US growth avoiding a recession and moderating global growth present a favorable backdrop for spread products and opportunities in emerging markets (EM) and structured credit.
This summary is intended to aggregate the Firm’s current overall views and present an at-a-glance dashboard.*
Growth
Convictions
- US growth is likely to slow from its firm levels, but the US should avoid a recession.
- Growth in Europe this year should be very tepid, at about 0%-1%.
- We expect China’s growth to be below its historical standard of 4%-5%.
- Global growth is downshifting, but remains positive overall.
Rationale
Inflation
Convictions
- Globally, overall disinflation trends are clear across developed market (DM) and emerging market (EM) economies, Europe and even China is seeing deflation pressures.
- UK inflation has been on a downward path, with recent prints also surprising to the downside.
- In the US, inflation is continuing to moderate but there was a slight spike in January/February that is expected to prove temporary; our view is that inflation is still progressing toward the Federal Reserve’s (Fed) 2% target.
Rationale
Rates
Convictions
- Market estimates of long-run neutral rates have increased by about 200 basis points (bps) since before the pandemic, reflecting a nominal rate close to 4% and a real rate close to 2%.
- EM central banks have already started to cut rates despite the Fed indicating no cuts will happen in the US until late-2024.
Rationale
Monetary Policy
Convictions
- The Fed sees a downward path for inflation while the US economy remains resilient, providing an opportunity for a rate cut.
- In the UK, the BoE is positioned to ease rates, potentially moving in tandem with or even before the Fed.
- The Bank of Japan moved away from negative interest rates and yield curve control due to rising wage growth and inflation above 2%.
Rationale
US Presidential Election
Convictions
- There are significant differences between the potential tax and tariff policies of the candidates, with Republicans likely to extend the 2017 tax cuts and Democrats potentially allowing them to expire.
- Tariff policy is also a point of contention, with President Trump favoring tariffs as a tool for industrial policy, while President Biden prefers subsidies for certain industries.
Rationale
Geopolitics
Convictions
- The reconfiguration of globalization, including nearshoring or friend-shoring, is influenced by geopolitical considerations, with countries reassessing their supply-chain dependencies to avoid potential adversaries.
- EM countries, particularly in Latin America, are expected to benefit from the evolution of global supply chains.
Rationale
*As of 31 Mar 24
- Global and US inflation has continued on a steady but uneven decline while generally growth has remained resilient, allowing for eventual central bank rate cuts.
- Disinflation is occurring broadly across DM, EM and frontier economies.
- Inflation in China has turned deflationary as the country stimulates its manufacturing sector to boost exports.
- The US economic outlook is stable, with a moderate growth slowdown expected, but no recession.
- Corporate fundamentals remain supportive with high profit margins, low debt growth and declining leverage for many non-financial issuers.
- We see value in sectors such as CMBS and EM debt, particularly in Latin America and Mexico.
Inflation: Higher for Longer and the Fed’s Easing Trajectory
Based on the latest inflation numbers, we recognize that inflation has come in higher than expected in this latest print but we don’t believe these idiosyncratic upside surprises are repeatable and should taper out over time. We continue to view the inflation picture as much better today than it was 18 months ago, allowing central banks to pivot from tightening monetary policy to preparing for easing.
The Federal Reserve (Fed) and Western Asset share the view that inflation is moderating over time. This perspective is supported by forward indicators such as rent price indices and used car prices, which suggest a positive direction in the control of inflation. The market is pricing in less than 50 basis points (bps) of rate cuts from the Fed in 2024, with expectations of the first cut occurring in the fall. This suggests that the market anticipates a cautious approach from the Fed in easing monetary policy, which could influence inflation trends.
Ballots, Bonds and Beyond: The Fed in Election Years
US Election
In the Firm’s recent PM Exchange webcast, hosted by Co-CIO Michael Buchanan, the upcoming US presidential election was discussed in the context of its potential impact on economic policies. It was noted that despite the significant differences in personalities and social issue stances between the major candidates, there are actually a few economic policies they share. Both candidates are focused on deficit reduction and maintaining a tough stance on China, to name just two. Our view is that the markets are not likely to have a dramatic reaction regardless of the election outcome, suggesting that the economic policies of either candidate won’t lead to significant market volatility.
EM Election Spotlight: Mexico and India
In a recent blog post by Product Specialist Robert Abad, he discusses the significance of the upcoming elections in Mexico and India, highlighting their potential impact on global growth and trade. Mexico’s presidential and congressional elections are set for June 2, 2024, with Claudia Sheinbaum of the Morena Party expected to win the presidency
Despite economic challenges and a downgrade in growth forecasts by the IMF, the Mexican peso has appreciated due to strong remittances and portfolio flows. Sheinbaum’s potential victory could lead to constitutional changes, particularly in the energy sector, and is seen as a positive for investment and trade with the US.
In India, parliamentary elections are scheduled from April 19 to June 1, 2024. Prime Minister Narendra Modi is anticipated to secure a third term, with the IMF raising India’s growth forecasts. The BJP seeks a supermajority to implement constitutional changes, including the “One Nation, One Election” agenda. However, concerns about Modi’s increasing power and its effect on India’s secularism persist.
From an investment perspective, we view Mexico’s local rates as attractive, and we’re approaching the peso tactically ahead of the elections. India’s bond market continues to offer high levels of yield and stability against global market fluctuations. As a result, we favor long positions in various Indian bonds and the Indian rupee.
Western Asset Investment Themes
| Asset Class | Our View |
|---|---|
| Overall Risk Assets | Spread sectors and risk assets are well-supported by the backdrop of moderating inflation and resilient growth. |
| Investment-Grade | Investment-grade corporate spreads have tightened to richly valued levels but can stay low given strong fundamentals. Rising foreign demand has contributed to investment-grade spread tightening in 2024 so far. |
| High-Yield & Bank Loans | High-yield bond defaults have increased modestly but remain below long-term averages. Higher interest rates pose limited refinancing risks for larger high-yield issuers. Fundamentals continue to be supportive. |
| Structured Product | Agency mortgage-backed securities (MBS) offer value relative to corporates if convexity risk is managed; commercial MBS (CMBS) still presents opportunities after outperforming in Q1, but issue selection is key. |
| EM Debt | EM local currency bonds have underperformed but are poised for outperformance as easing cycles begin. Mexico EM debt in particular could benefit from nearshoring of supply chains closer to the US. |
