Scenarios Meet Solutions

With inflation at historic highs immediately following the unprecedented Covid period and volatility continually jolting markets, economic uncertainty had been the dominant theme. Though Western Asset's base case expects slowing growth and moderating inflation, we recognize the need to scope out a variety of potential market outcomes. Here we present three distinct scenarios, the likely investment implications and Western Asset's investment solutions that we believe could be most appropriate.

DOWNLOAD THE BROCHURE
  • Global growth remains resilient with the US slowing but avoiding a recession
  • Global inflation continues to recede, in part, on stabilizing commodity prices
  • Market expectations for future rate cuts accelerate
  • In this scenario, we favor high-quality, higher-yielding, diversified strategies for income and total return
  • The backdrop here should be particularly favorable for spread products to outperform
  • This environment should also be positive for rate compression

Our base case calls for a fairly optimistic scenario, with falling inflation and fairly resilient growth. We expect global growth to remain resilient but US growth will slow, but avoid a recession. Global inflation should continue to recede. Market expectations for rate cuts are likely to accelerate. Under this scenario, we favor high-quality, higher-yielding diversified strategies for income and total return.

  • Global growth conditions are buoyed by a China recovery
  • US growth achieves a soft landing
  • Global inflation surprises to the downside, aided by lower energy prices
  • Global financial conditions normalize
  • This outcome would result in steady economic growth that prevents a recession, but without excessive growth that might fuel too much inflation
  • Here we favor corporate bonds and total-return-focused strategies
  • Risks to this outlook are more balanced, with the Fed able to guide rates lower to support economic activity
  • With the US dollar weakening modestly, we would expect credit spreads to grind tighter

This scenario is one of stronger growth and weaker inflation than that of our base case. Global growth would improve, aided by China's recovery, and global inflation would be lower than expected. The US economy would likely achieve positive growth, but not excessively. This outcome would result in steady economic growth that avoids a recession, but without too much growth that might trigger additional inflation. Here we would favor corporate bonds and total-return-focused strategies.

  • Global growth weakens materially
  • Refinancing and default risks rise among various DM corporate and EM sovereign issuers
  • The Fed and other central banks bring forward rate cuts to support economic/financial conditions
  • Here we favor defensive strategies to weather credit-spread widening and increased market volatility
  • Global growth stagnates or decelerates
  • Headline and core inflation reaccelerate and remain stickier for longer
  • The Fed and other central banks resume hawkish stance and telegraph more rate hike
  • In this scenario, we favor cash-based and inflation-protection strategies until inflation momentum shows sustained signs of abating

Here we could see either a "hard landing" with a sharp drop in growth, or stagflation where inflation takes off again. Persistently high inflation could lead central banks to abandon expected rate cuts and instead pivot to additional hikes to contain prices. If we see either of these outcomes, portfolios with limited credit exposure and more interest rate risk would be better positioned to outperform.

As of 31 Jan 24.
Scenarios and Investment Implications are for illustrative purposes and are based upon Western Asset's observations and experience. Investment Implications are subject to change with market conditions. The fixed-income solutions suggested should be considered in the context of an investor's overall investment portfolio.

*Customized solution. Please contact us for more information.

CONTINUE READING

The New Case for Fixed-Income

An ideal time to embrace fixed-income as part of a diversified portfolio

Read More