With portfolio managers across fixed income asset classes navigating the rate cutting cycle, Kaspar Hense, Senior Portfolio Manager, discusses how investors can maintain their income, as we head into final stretch of the year.
With central banks across the globe embarking on a cutting cycle, we have entered a ‘golden era’ for fixed income, which puts ample opportunities on the table.
Despite long-end yields reaching 5% at the end of 2023, volatility over 2024 has diminished the risk-return profile1.
From here onwards, we are more likely to see a sideways trending market, which provides strong opportunities for pension investments to lock in long-end yields of up to 4.5% for the asset class. Looking at equities, in contrast, it is questionable whether they can compete, given that we expect sustained high valuations, a more pronounced landing for the economy, and a decline in household income growth.
In our view, yields, especially in the front end, have rallied too far and are pricing in a rather imminent hard landing à la 2008. This is certainly not our base case. Front-loading rate cuts to ‘neutral’ will be a challenge. While financial assets may react positively to rate cuts, the real economy will initially be negatively impacted by higher prices, which would weaken affordability even further.
While that leaves us with a positive structural view, we are tactically cautious in the short term, for now. Certainly, active management will be able to extract further performance in most areas including high yield, emerging markets (particularly local markets), as well as Agency MBS, EU banks and EU periphery spreads.
However, there may be clouds on the horizon given that monetary policy has a lag. In our view, this may be longer than in the past, due to longer maturity of corporate and government debt.
That means that high cash rates will continue to bite, and the interest cost of debt will still rise, despite rate cuts. In that sense, it looks more like an end cycle (than mid cycle) and may require significant investment to avoid a harsher slowdown at the end of 2025.
After the first 50bps cut by the Fed, we think it will be difficult to keep up the speed, with inflation sticky and the labour market to hold up this side of the year. This leaves us short the very front end in our global government bond offering, however, we see room for more cuts further out.
1 Bloomberg