Schroder: Lowering the possibility of the U.S. economy "not landing" improves the outlook for the global bond market

According to the Wise Finance APP, Schroders stated in a post that major central banks around the world are currently preparing for interest rate cuts. The European Central Bank (ECB) has already cut interest rates in early June 2024, and the Bank of England may follow suit. In addition, there have been preliminary signs in the past month that the US economy is slowing down and inflation data is improving. As a result, the bank has reduced the possibility of an economic "hard landing" and increased the possibility of a "soft landing". If the momentum of economic growth continues to weaken, this will create a favorable environment for the Federal Reserve to begin lowering policy rates later this year. Due to the reduced possibility of an economic hard landing, the bank has improved its outlook for the global bond market.

Currently, major central banks around the world are preparing for interest rate cuts. The European Central Bank (ECB) has already cut interest rates in early June 2024, and the Bank of England may follow suit. However, despite other major central banks stating that their interest rate decisions will not be influenced by the actions of the Federal Reserve, the Federal Reserve's decisions will have long-term effects on the overall financial markets, including the difficulty for consumers and businesses to obtain financing, as well as significant impacts on commodity prices and currency exchange rates. If a continued slowdown in US economic growth is truly observed, this will help the Federal Reserve to begin lowering policy rates later in 2024.

In the past month, there have been preliminary signs that the US economy is slowing down and inflation data is improving. Therefore, the bank has reduced the possibility of an economic "hard landing" and increased the possibility of a "soft landing" (the bank's basic forecast scenario). In fact, the impact of the economic slowdown is already reflected in various economic indicators, from consumer confidence, job turnover rates to initial claims for unemployment benefits, indicating that previous concerns about an overheated labor market may have been overstated. Among them, non-farm employment numbers are key data. Data for April and May 2024 show a slowdown in job growth in core industries (private enterprises excluding healthcare), which is a positive sign.

Regarding inflation, as geopolitical tensions ease, oil prices have fallen from their highs in April 2024. At the same time, consumer price index (CPI) data for April and May in the US have further improved, especially in core industries such as services excluding housing. For the Federal Reserve and the financial markets, overall inflation in the US remains at a relatively high level, but has improved compared to the first quarter, which is an important step in the right direction. The bank believes that if the momentum of economic growth continues to weaken, this will create a favorable environment for the Federal Reserve to begin lowering policy rates later this year.

The bank points out a puzzling phenomenon in the financial markets, where the ISM Services Purchasing Managers' Index (PMI) fell below 50 for the first time in over a year in April 2024, indicating industry contraction with noticeable weaknesses in new orders, employment, and production. However, the specific reasons for this situation are not yet clear, and this indicator, which has always been considered forward-looking, seems less reliable post-pandemic. Now, it seems premature to raise the risk of an economic "hard landing" based on a weak survey index. However, in the coming months, the bank will scrutinize service industry data more rigorously than usual, including official data and survey data Due to the possibility of the economy not landing (in this case, bond returns will be severely affected), the bank has improved its outlook for the global bond market. In addition, the latest meeting of the Federal Reserve eliminated discussions on whether the central bank will further raise interest rates in the event of strong economic data (this dynamic is crucial). All of this proves that it is reasonable to continue to be optimistic about the global duration (or interest rate risk).

The bank's fixed income asset allocation has changed relatively little compared to last month, with only a slight increase in views on local currency bonds in emerging markets. The bank remains optimistic about mortgage-backed securities (debts consisting of loans with individual collateral as repayment guarantee), agency mortgage-backed securities, short-term European investment-grade credit, and semi-sovereign debt, and is underweight in U.S. investment-grade credit and global high-yield bonds due to relatively low valuation attractiveness. (Investment-grade bonds are the highest quality bonds determined by credit rating agencies; high-yield bonds are more speculative, with credit ratings lower than investment-grade bonds.)