Market Insights at a Glance
We believe the global economic outlook for fixed-income investments is optimistic, as central banks begin to ease policy and inflation is moderating, aligning with our base case. Despite tight spreads, our view is that we can identify attractive yields selectively and strong fundamentals support maintaining exposure to various spread sectors, emphasizing higher-quality assets for resilience against potential economic headwinds.
This summary is intended to aggregate the Firm’s current overall views and present an at-a-glance dashboard.*
Growth
Convictions
- We anticipate the US will achieve a soft landing, but with unemployment rising due to labor force expansion rather than layoffs.
- Eurozone growth remains weak, with industrial production and confidence indicators showing continued decline.
- China’s growth is supported by broad stimulus packages, but long-term structural issues like demographics and housing remain unaddressed.
Rationale
Inflation
Convictions
- The US disinflation trend is ongoing but uneven, with inflation nearing the Federal Reserve’s (Fed) 2% target, as goods inflation is running below pre-pandemic levels and service sector inflation is expected to decline.
- Eurozone inflation is nearing the 2% European Central Bank’s (ECB) target as goods prices dramatically fall.
- Global inflation is moderating, driven by significant declines in goods inflation.
Rationale
Rates
Convictions
- US Treasury yields are expected to decline further, with markets anticipating an additional 50 basis points (bps) of rate cuts before year-end.
- Eurozone yields, particularly in 5- and 10-year German government bonds, may offer good relative value due to weaker economic growth and expected declines in service inflation.
- UK gilts are likely to outperform as the terminal-rate pricing is still elevated relative to where it should be.
Rationale
Monetary Policy
Convictions
- The Fed has shifted its focus from inflation to the labor market, with further rate cuts anticipated.
- The ECB has cut its deposit rate by 50 bps so far, with policy rates still high relative to historical averages given the weak economic environment.
- Emerging market (EM) central banks, having tightened policy ahead of the Fed, are now resuming or accelerating rate cuts as global inflationary pressures abate.
Rationale
US Presidential Election
Convictions
- A sweep by either US presidential candidate is seen as more concerning, potentially leading to a more complete implementation of their proposed agendas.
- A split government is viewed as more favorable for investors, as it would likely face significant resistance to sweeping policy changes and help contain fiscal spending.
- The biggest differences between the candidates are expected in regulation and tax policy, with Trump favoring deregulation.
Rationale
Geopolitics
Convictions
- The upcoming US presidential election is highly uncertain, with neither candidate being particularly bond-friendly and both likely to lead to further fiscal expansion.
- The potential for increased tariffs remains. While both US presidential candidates have previously used tariffs, Trump may potentially adopt a more progressive stance in their application.
- Current geopolitical events, such as the Middle East conflict, add uncertainty and potential inflationary pressures.
Rationale
*As of Oct 16, 2024
Ahead of the Vote—Fixed-Income in an Election Year
The 2024 US presidential election outlook remains highly unpredictable, with current market indicators and betting odds continuing to fluctuate and showing no clear frontrunner. This uncertainty in the run-up, let alone the final results, could lead to shifts in fiscal policies and regulatory frameworks, and potentially influence market behavior. Given these factors, a prudent investment strategy involves maintaining a well-diversified portfolio to adapt to various possible outcomes. For an in-depth analysis of potential election scenarios for fixed-income investors—including global elections and a detailed look at the US race—please check out our comprehensive guide, Ballots, Bonds & Beyond.
Soft Landing Still in Play: Western Asset’s Base Case Coming to Fruition
Our base-case investment thesis—slowing inflation, moderate but still positive growth in the US without a recession—is coming closer to becoming reality as the US economy remains resilient. This aligns with the ongoing trend of global disinflation, which continues to progress positively. Together, these developments set the stage for further central bank rate cuts later this year and beyond. We believe this shift provides a favorable backdrop for fixed-income investors.
- The Fed has shifted its focus from inflation to the labor market, which is supported by recent statements from Fed Chair Jerome Powell and other Fed officials.
- The unemployment rate has been trending higher from historically low levels. This increase is largely due to an expansion in the labor force rather than a surge in layoffs.
- The Fed’s outlook is generally optimistic, aiming for a soft landing where unemployment rises modestly without triggering a recession. The possibility of higher unemployment without a corresponding increase in layoffs supports this view.
The Fed, Global Central Banks and the Start of the Easing Cycle
Central banks around the world have shifted toward monetary easing to counteract slowing economic growth and bring inflation back to target levels (generally 2%). This policy shift includes interest rate cuts and other measures aimed at stimulating economic activity. Here’s a closer look.
The Fed
- The Fed reduced the fed funds rate by 50 bps in September and markets are pricing in another 50 bps in cuts before year-end.
- Fed policy is expected to remain data-dependent, with room for additional rate cuts next year and beyond if necessary.
- Events like Middle East tensions and potential oil price inflation add complexity, requiring the Fed to stay flexible and responsive to both domestic and international developments.
Other Major Central Banks
- The ECB has cut its deposit rate by 50 bps so far, with expectations for further cuts due to weak economic conditions and inflation returning to target levels.
- The Bank of England has also cut rates and is expected to continue easing monetary policy to support the weakening UK economy.
- The Bank of Japan, in contrast, has just begun tightening policy, with rates expected to rise to 1.0% by next year due to structural issues like poor demographics and low immigration contributing to higher inflation.
- The Reserve Bank of Australia has paused rate adjustments and is expected to remain on hold until core inflation shows further progress, with potential easing by 2Q25.
EM Central Banks
- Central banks in EM countries have led the easing trend, often preceding the Fed. This has pushed real yields higher to combat inflationary pressures.
- As global inflation moderates, EM central banks are resuming or accelerating rate cuts, creating a favorable backdrop for local yields in EM economies.
Opportunities in Fixed-Income and Investment Themes
- Despite tight spreads in various credit sectors, robust fundamentals suggest potential stability. Given this environment, our emphasis is on maintaining exposure to sectors offering attractive relative value.
- Structured products, including agency mortgages, commercial mortgage-backed securities, and collateralized loan obligations, may provide attractive yield opportunities and diversification benefits. Despite some sector-specific risks, our view is that the structural integrity and yield advantages of these products make them valuable components of fixed-income portfolios. Of course, active management and careful selection are essential to navigate the complexities and risks inherent in today’s markets.
Western Asset Investment Themes
| Asset Class | Our View |
|---|---|
| Overall Risk Assets | Despite tight spreads, we are maintaining exposure to spread sectors for their income carry advantage, supported by strong fundamentals and a favorable central bank policy environment. |
| Credit Sectors | We are focusing on higher-quality investments within credit sectors to build resilient portfolios, given the strong fundamental backdrop and potential for unforeseen economic headwinds. |
| Investment-Grade Credit | Fundamentals remain supportive with positive revenue growth and low leverage, making investment-grade credit attractive despite tight spreads. We are selectively trimming exposure but maintaining a focus on quality. |
| High-Yield Credit | The high-yield market is currently benefiting from low default rates and strong fundamentals, particularly in higher-quality segments. We are migrating toward higher-quality high-yield bonds to mitigate risks. |
| Structured Product | We favor US agency mortgages due to limited supply and attractive spreads relative to high-quality, short-dated corporate bonds. We are also increasing exposure to commercial real estate, particularly in sectors like retail and industrial, while being cautious with office properties. |
| EM Debt | We see value in local EM debt in the larger EM economies and are also exploring opportunities in frontier markets. EM local yields are expected to continue rallying as EM central banks ease policy. |
| Geopolitical and Economic Risks | Current events such as Middle East tensions and proposals for inflationary trade policies are being closely monitored for potential inflationary impacts. |
