Market Insights at a Glance
We believe that the ongoing disinflation process, combined with moderate global growth and the potential for central banks to ease monetary policy, presents a favorable backdrop for fixed-income markets. This summary is intended to aggregate the Firm’s current overall views and present an at-a-glance dashboard.*
Growth
Convictions
- We expect US growth to slow somewhat, at about a 2% rate for the year.
- With Europe on the brink of a recession, we expect only weak growth there.
- China’s growth target of 5% may be difficult to achieve considering property sector headwinds.
- Global growth overall has already started to downshift.
Rationale
Inflation
Convictions
- US inflation is receding and we expect the downward trajectory to continue. Core CPI is running at about 3%, down from 7.5% a year ago.
- UK inflation has been on a downward path, with recent prints also surprising to the downside.
- Inflation in China is not considered a problem, and China could even become a source of deflation.
Rationale
Rates
Convictions
- Real rates in the US are still high, and market estimates of the longer-term neutral rates are elevated compared to the Fed’s current expectations.
- Emerging market (EM) rates are elevated, and with an easing cycle about to start and FX expected to be well-behaved, there is optimism for EM local currency opportunities.
Rationale
Monetary Policy
Convictions
- The Fed has shifted from a stance of aggressive tightening to a more accommodative position, with the possibility of rate cuts in 2024.
- The European Central Bank has been cautious but is expected to shift to a less restrictive policy as growth and inflation remain subdued.
- The Bank of England is anticipated to shift to a less restrictive policy regime due to subpar growth and developing labor slack.
Rationale
Banking
Convictions
- Fears of a banking sector collapse erupted in early 2023, but markets have since realized that vulnerabilities were idiosyncratic and limited to smaller less-regulated regional banks.
- Despite waning systemic fears, the Fed’s quarterly Senior Loan Officer Opinion Survey (SLOOS) has shown that banks tightened lending standards.
- The SLOOS also indicated loan demand fell across all types in 2023.
Rationale
Geopolitics
Convictions
- Geopolitical uncertainty continues to add volatility to the markets.
- There is a trend toward "nearshoring" or "friendshoring," where supply chains are being reconfigured to rely on countries that are not seen as adversarial, benefiting countries like Mexico.
- The war between Russia and Ukraine has significant implications, particularly for China, as it raises questions about the investability of the region.
Rationale
*As of 31 Dec 23
- The Firm expects a fairly optimistic scenario will be the most likely outcome, with a falling inflation rate and resilient growth.
- We believe that global growth will remain resilient with US growth slowing but avoiding a recession.
- Global inflation should continue to recede, in part motivated by stabilizing commodity prices.
- We think expectations for future rate cuts are likely to accelerate.
- We favor high quality, higher yielding, diversified strategies for income and total return; we expect generally slower growth, which is distinct from no growth.
- Our higher quality bias in credit, in addition to some select floating-rate exposure in structured credit and loans should provide some portfolio resilience should central banks move back to more restrictive policies.
The Difference a Year Makes
The dramatic drop in inflation globally over the past year has allowed central banks to pivot from tightening monetary policy to preparing for easing. This shift has fueled powerful rallies across most areas of fixed-income. We expect further disinflation ahead, albeit unevenly, as global economic growth moderates. Downshifting global growth, falling inflation trends and central bank easing provide a favorable backdrop for fixed-income heading into 2024. Risks remain due to geopolitical uncertainty, central banks potentially moving too slowly or a sharp slowdown in growth. We see particular value in some spread sectors such as select portions of the commercial mortgage-backed securities (MBS) sector, BB high-yield bonds and EM debt, particularly Latin America.
The Case for Fixed-Income in 2024
The recent improvement in the economic landscape suggests a promising outlook for fixed-income this year, as declining inflation trends are likely to prompt the Fed to cut rates. Historically, bonds have yielded positive returns following a cessation of rate hikes (Exhibit 1), and the current hiking cycle which commenced in March 2022 is expected to pivot to rate cuts later this year. Learn more here.
Cash Is Not Always King
Cash-equivalent investments (money markets, CDs, etc.), while often considered a safe haven, are not necessarily superior to fixed-income. Historically, they have been notably poor performers when compared to other asset classes, offering minimal growth potential. Additionally, the strategy of market timing, which includes tactical cash allocations, is rarely effective and does not typically yield better results than a well-diversified portfolio.
Unlike cash investments that have zero correlation to stocks and merely dilute a portfolio’s overall performance, fixed-income investments can offer negative correlation to stocks, providing a valuable offset to risk and enhancing a portfolio’s resilience. Furthermore, fixed-income investments mitigate reinvestment risk by typically offering a range of maturities and interest rates, allowing for strategic reinvestment that can adapt to changing economic conditions, something that cash-like investments cannot match.
What’s more, bonds have a long history of negatively correlating to stocks (Exhibit 2), whereas cash has been nearly uncorrelated. During US recessions, bonds have successfully served investors as both an offset to equity risk and a good source of returns relative to cash, with the average cumulative return for bonds, once again, doubling the return on cash investments.
Read more about this topic in our blog from Western Asset Client Service Executive Bryan Zak.
Western Asset Investment Themes
| Asset Class | Our View |
|---|---|
| Overall Risk Assets | Strong corporate fundamentals and central bank easing provide a favorable backdrop for risk assets, though parts of credit markets appear richly valued following sharp rallies. Selectivity is warranted and we maintain a bias to go up in quality. |
| Investment-Grade | Current valuations appear somewhat expensive. Fundamentals remain supportive given balance sheet improvements. |
| High-Yield & Bank Loans | Rising stars (BB high-yield issuers that are poised to be lifted (upgraded) into investment-grade) offer particular value with additional room for price gains and upgrades yet to be fully reflected. Bank loans can provide floating-rate income buffers amid a rising-rate environment, but upside may be limited at this later stage of the cycle. |
| Structured Product | Agency MBS provide relatively attractive yield profiles with the sector poised to benefit should the Fed slow its mortgage runoff pace. Parts of non-agency residential and commercial MBS offer selective value but require in-depth credit analysis. |
| EM Debt | EM local debt stands out for its attractive valuations and high real yields as EM central banks pivot to cuts. USD-denominated sovereign issuers also merit consideration. |
