The global investment landscape is on the brink of change as major economies’ trajectories diverge noticeably. According to researchers, central banks, once unified in tightening policy to counter the pandemic-induced inflation spike, are now anticipated to pursue diverse paths in adjusting interest rates.
According to a report by asset manager Pimco, despite many large, developed market economies experiencing a slowdown, the US has managed to maintain momentum, buoyed by supportive factors expected to persist. However, this growth could potentially keep US inflation lingering above the Federal Reserve’s 2% target over the next six to 12 months.
While an economic soft landing remains achievable in the US, risks in both directions – from recession to rekindled inflation – remain elevated in the aftermath of unprecedented global shocks to supply and demand, the report highlighted.
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The researchers picked bonds as an attractive option amid the ongoing uncertainty, offering nominal and inflation-adjusted yields along with the potential to weather various economic conditions. According to the researchers, intermediate maturities, in particular, are a “sweet spot”, balancing fleeting yields in cash and potential pressure on long-duration bonds from rising bond supply.
The report highlighted the attractiveness of bond markets outside the US, especially in countries where inflation risks are perceived to be less pronounced, such as the UK, Australia and Canada. Additionally, given the resilience of the US economy, preference is shown towards the US dollar over the euro and other European currencies.
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With the US 10-year yield hovering around 4.25%, the researchers advised a neutral stance on duration. “Short-dated yields are deemed fair and align with our baseline expectations over our cyclical horizon. In US and global core bond portfolios, we maintain a slight duration underweight, reflecting a recent market rally. Our focus remains on global relative value and yield curve positioning strategies. Additionally, we hold an underweight view towards the long end of the US curve due to apprehensions about fiscal policy and Treasury supply,” stated the report.
The report also estimated the traditional inverse correlation between stocks and bonds to resume, potentially leading to appreciation in fixed income investments if the pricing of recession risk increases again.
The report concluded that the current environment underscores the importance of global diversification, prudent risk mitigation and constructing resilient portfolios through active management.
